**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-K**





x            
      Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act
      of
      1934.  For the fiscal year ended June 30, 2007.





o            Transition
      report pursuant to Section13 or 15(d) of the Securities Exchange Act of
      1934.  For the fiscal year ended June 30, 2007.





Commission
      file number 000-25839





**IMPLANT
      SCIENCES CORPORATION**


(Exact
      name of registrant as specified in its charter)





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





781-246-0700


(Registrant’s
      Telephone Number, Including Area Code)





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





Title
                of Each Class
            
            Name
                of Each Exchange on Which RegisteredCommon
                Stock, $0.10 par value
            
            American
                Stock Exchange








Indicate
      by checkmark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities
      Act. YES  
      o  
No  x





Indicate
      by checkmark if registrant is not required to file reports pursuant to Section
      13 or Section 15 (d) of the Act. YES  
      o 
 No  x





Indicate
      by checkmark 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  o





Indicate
      by check mark if disclosure of delinquent files pursuant to Item 405 of
      Regulation S-K is not contained herein , and will not be contained, to the
      best
      of registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form
      10-K.                  
No Disclosure  x





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





Large
      Accelerated Filer  o                                                      Accelerated
      Filer o                                          Non-Accelerated
      Filer  x





Indicate
      by checkmark whether the registrant is a shell company (as defined in Rule
      12B-2
      of the Exchange Act)     YES   o   No 
x




The
        aggregate market value of the voting stock held by non-affiliates of the
        registrant was approximately $20,281,462 as of October 11,  2007
        (based on the closing price for such stock as of October 11, 2007).
  Indicate
        the number of shares outstanding of each of the issuer’s classes of common
        stock:
 
 Class
              Outstanding
                  at October 11, 2007Common
                  Stock, $0.10 par value
              11,835,661










**PART
      1**





**SPECIAL
      NOTE ON FORWARD LOOKING STATEMENTS**





*In
      addition to historical information,
      this Annual Report on Form 10-K contains forward looking statements within
      the
      meaning of the Private Securities Litigation Reform Act of 1995. The words
      “believe,” “expect,” “anticipate,” “project,” “estimate,” “forecast,” and
      similar expressions, among others, identify forward looking statements. The
      forward-looking statements are subject to certain risks and uncertainties that
      could cause actual results to differ materially from those reflected in such
      forward-looking statements. Factors that might cause such a difference include,
      but are not limited to, those discussed in the sections entitled “Business,”
“Risk Factors,” and “Managements Discussion and Analysis of Financial Condition
      and Results of Operations.” Readers are cautioned not to place undue reliance on
      these forward-looking statements, which reflect management’s opinions only as of
      the date thereof. We undertake no obligation to revise or publicly release
      the
      results of any revision of these forward-looking statements. Readers should
      carefully review the risk factors described in the Annual Report and in other
      documents that we file from time to time with the Securities and Exchange
      Commission.*




**ITEM
      1.             OUR
      BUSINESS**




Over
      the past twenty three years,
      Implant Sciences Corporation (the "Company"), incorporated in August 1984,
      has
      both developed and acquired technologies using ion implantation and thin film
      coatings for semiconductor and medical device applications, including the
      modification of orthopedic joint implant surfaces to reduce polyethylene wear
      generation and the coating of cardiovascular devices.  This technology
      has further evolved to include new applications in the area of trace explosives
      detection products.





Since
      May 1999, we have been performing
      research to develop and improve trace explosives detectors, which could be
      used
      to detect hidden bombs in airports and other public places. This is the latest
      application of our ion source technology. At present, we have developed both
      portable and bench-top systems for use in airports and Department of Defense
      facilities and have marketed and sold these products both domestically and
      internationally.   In fiscal 2006, as part of a plan to reduce
      manufacturing costs, we transitioned the production of our handheld system
      to a
      contract manufacturer. As we continue to sell and deliver our security products,
      we work both independently and in conjunction with various government agencies,
      to develop the next generation of trace explosives detectors and to identify
      new
      applications for our proprietary technology. We currently have six issued United
      States patents and five United States patents pending covering our explosives
      detection technologies and processes.





Other
      applications of our ion beam
      technology had been in the area of temporary brachytherapy products. In May
      1999, we received Food and Drug Administration 510(k) clearance to market our
      I-PlantTM
      Iodine-125 radioactive seed for the treatment of prostate cancer and in 2001
      recognized our first sale. This marked a major milestone for the Company by
      commercializing a product derived from a research and development program as
      well as representing a critical stage in our growth from a provider of ion
      implantation services for semiconductor and orthopedic applications to a
      manufacturer and seller of product in the form of radioactive prostate
      seeds.  In June 2007, we sold certain assets associated with this
      product and divested the prostate seed and medical software business and will
      now only supply services and components of this product
      line.  Management is currently working on a plan to keep the remaining
      assets in service.  However, should management be unsuccessful in
      formalizing this plan, there is a possibility that future periods may report
      discontinued operations relating to these remaining assets.





Our
      semiconductor business experienced
      substantial growth in FY 2005.  This growth came through the
      acquisition of two California semiconductor companies, Core Systems, Inc.
      (“Core”) and Accurel Systems International Corporation (“Accurel”) in October
      2004 and March 2005 respectively.  Through these acquisitions, we more
      than doubled our semiconductor capacity and were able to offer diagnostic
      services, semiconductor equipment and refurbishment services to semiconductor
      manufacturers, research laboratories and universities.  In May 2007,
      we sold our Accurel subsidiary which provided semiconductor analytical
      services.





We
      currently have fourteen issued
      United States patents and three United States patents pending covering our
      semiconductor and medical technologies and processes.





2








**Technologies**





*General.*We
      use three core
      technologies, ion implantation, thin film coatings and ion mobility spectrometry
      (“IMS”). With respect to each technology, we have developed proprietary
      processes and equipment for the purpose of improving or altering the surfaces
      of
      medical implants and semiconductor wafers and the ionizing and detection of
      trace explosives molecules.




Ion
      implantation and thin film coatings
      are techniques first developed in the 1970’s to improve the functional surface
      properties of metals, ceramics and polymers, such as friction, wear, wetability
      and hardness. Ion implantation was initially developed as a means to dope
      semiconductors in the fabrication of integrated circuits. The accuracy,
      cleanliness and controllability of this process have made it the standard for
      semiconductor manufacturing. Ion implantation is generally preferred over other
      surface modification methods because it does not delaminate, does not require
      high temperatures and does not deform or alter the dimensions of the treated
      surface.





Thin
      film coatings were initially
      developed to interconnect transistors on semiconductor chips. Thin films modify
      surfaces by layering a desired metal or ceramic coating on the substrate
      material. Common thin film coating techniques include chemical vapor deposition
      and physical vapor deposition.





Ion
      mobility spectrometry, as opposed
      to the first two technologies, uses an ion beam to measure properties of the
      precursor molecules.  IMS uses an ionizer to convert the subject
      molecules into ions so they can be accelerated by electric fields and travel
      down a cylindrical tube in an air medium.  The measurement of the time
      of flight through a fixed distance enables the instrument to determine the
      mass
      and the relative concentration of the subject molecules in the analysis
      volume.  This technology is particularly well suited to measure the
      identity and amount of explosives and/or narcotics vapor in air.





*Ion
      Implantation.*Ion
      implantation is a process by which ions (electrically charged atoms) are
      accelerated to high velocity in a vacuum and directed toward a substrate or
      target material. The atoms become embedded just below the surface of the
      material producing an alloy composed of the atoms and the substrate material
      in
      the near-surface region of the target material. This surface alloy may have
      new
      mechanical, electrical, chemical, optical and other properties. We believe
      our
      proprietary technology, including high current ion sources and specialized
      component holding fixtures, provides higher ion implant doses and higher beam
      power and yields superior surface characteristics at lower cost than
      commercially available equipment.





Ion
      implantation can be used to embed
      single isotopes of radioactive or non-radioactive elements into components.
      We
      are using our proprietary equipment to manufacture radioactive seed implants
      for
      the treatment of prostate cancer and other carcinomas which can be manufactured
      without expensive cyclotrons or linear accelerators and without hazardous
      radioactive wet chemistry, the methods currently employed by existing
      suppliers.





*Thin
      Film Coatings.*A thin
      film coating is grown upon a substrate in a vacuum by the gradual deposition
      of
      atoms on the substrate. Our proprietary unbalanced magnetron sputtering process
      results in coatings that are extremely dense and free of voids, yielding good
      contrast and sharp edges under x-ray or fluoroscopic examination. These coatings
      usually consist of gold or platinum for radiopaque applications. Our proprietary
      manufacturing process allows for efficient utilization of precious metals and
      for cost effective recovery and recycling of these precious metals. We are
      also
      developing processes to coat stents, guidewires and catheters used in
      interventional cardiology procedures with substances, usually gold or platinum,
      that allow those stents, guidewires and catheters to be visible under x-ray
      observation during a procedure. We believe other techniques for applying thin
      film coatings are less desirable for medical device applications because of
      their inability to apply a dense coating, while continuing to be flexible and
      adhering to the substrate.





*Trace
      Explosives Detection.*We
      have developed instruments which can detect the vapor from trace amounts of
      explosive compounds including plastic explosives such as RDX, the compound
      commonly found in C4 explosives. The systems works by ionizing explosive
      molecules in an air sample and then detecting the ionized molecules of the
      explosive using ion mobility spectrometry. The instruments have successfully
      detected molecules of five different types of explosives in the air at the
      parts
      per trillion concentrations. We believe this technology will provide commercial
      systems with improved sensitivity and capabilities than equipment presently
      available.





3








**Security
      Products**





*Trace
      Explosives Detection Equipment*





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





This
      product development has been
      ongoing since May 1999. This project was undertaken in response to the interest
      in ion beam phenomena by our research personnel who are constantly researching
      new applications for this technology. The development of new applications is
      typically funded through government grants or internal funding.





In
      June 2000, we developed our first
      experimental device, which demonstrated sensitivity to the explosive
      TNT.  In fiscal 2005 we began taking orders for and shipping product
      previously under development.  New models with various special
      detection and sample acquisition capabilities have been developed almost on
      a
      yearly basis since then.  These devices are able to detect and specify
      an increasing number of compounds within various explosive materials. The
      explosives that have been tested to date are TNT, RDX, PETN, EGDN,
      nitroglycerin, black powder, various smokeless powders, nitrocellulose, ammonium
      nitrate, urea nitrate, guanidine nitrate, TATP, HMTD, HMX, tetryl, and
      DNT.  RDX is the primary component of C3 and C4 explosives, such as
      Detasheet and Semtex, as well as certain types of black powder
      explosives.  We believe these explosives represent the majority of the
      explosives presently used in terrorist activities.  The Company
      currently offers the QS-H150 portable detector, the QS-BP100 backpack-based
      portable explosives detector, and the QS BTS-150 benchtop detector.





The
      electronic detection system detects
      microscopic quantities of explosive molecules in the air. The device does not
      use any radioactive materials and does not produce a danger to personnel
      operating the device or scanned by the device. The device is a sensor that
      receives signals that are already in the environment. Our electronic detection
      system uses a sensor that does not require physical contact to screen the
      article to detect trace residues. Since our device does not use a radioactive
      source, management believes it is safer than trace explosives residue detection
      systems currently in use.





Consistent
      with our policy to protect
      our proprietary technologies, we have been awarded six patents and submitted
      five additional patent applications to the United States Patent and Trademark
      Office. These patent applications will cover specific design configurations
      that
      are responsible for our improved vapor detection sensitivity. The Company has
      outsourced the manufacturing of our current trace explosives detector products
      to a contract manufacturer.








**Semiconductor
      Products**





*Semiconductor
      Ion Implantation*





*General.*We
      supply ion
      implantation services to numerous semiconductor manufacturers, research
      laboratories, and research universities. Ion implantation of electronic dopants
      into silicon, the process by which silicon is turned into a semiconductor,
      is an
      integral part of the integrated circuit fabrication process. While many of
      our
      customers have their own ion implantation equipment, they often use our services
      and specialized expertise for research and new product development because
      they
      do not want to interfere with production or because they are unable to perform
      the services themselves.





In
      October 2004, we acquired Core
      Systems and doubled our semiconductor ion implantation equipment and capacity.
      This acquisition enabled us to expand our revenue base by affording us the
      opportunity to service a new pool of customers not available to us in the past
      as our existing ion implantation equipment limited our processing capabilities.
      In addition, through this acquisition, new revenue opportunities were gained
      the
      areas of semiconductor equipment refurbishing services and the sale of source
      conditioning equipment.  In March 2005 we acquired Accurel
      Systems, and thru this acquisition, was able to offer analytical and
      failure analysis diagnostic services to the manufacturers of semiconductor
      products.  In May 2007, we sold the assets of Accurel
      Systems.








4








**Medical
      Products**





*Permanent
      Implants for the Treatment of Prostate Cancer*





*General.*The
      alternatives
      generally presented to patients diagnosed with early stage prostate cancer
      are
      surgical removal of the prostate (radical prostatectomy) or external beam
      radiation. Both techniques frequently have significant side effects including
      impotence and incontinence. Brachytherapy has been an increasingly popular
      treatment technique whereby radioactive seeds (each of which is approximately
      half the size of a grain of rice) are permanently implanted into the prostate.
      This technique allows the delivery of highly concentrated yet confined doses
      of
      radiation directly to the prostate. Surrounding healthy tissues and organs
      are
      spared significant radiation exposure. Advances in transrectal ultrasound and
      computed tomography imaging equipment provide detailed and precise measurements
      of prostate size and shape, for seed distribution and placement.





*Prostate
      Seeds.*We have
      developed, and been granted seven United States patents covering radioactive
      seeds, implants and methods of manufacturing radioactive seed implants by a
      proprietary process and other brachytherapy applications. We have received
      Food
      and Drug Administration 510(k) clearance to market our I-PlantTM Iodine-125
      radioactive seed for the treatment of prostate cancer. Our 510(k) clearance
      permits treatment of any localized tumors treatable by temporary or permanent
      brachytherapy. A twelve-year study conducted by the Northwest Hospital, Seattle,
      Washington shows that this treatment has a twelve-year disease-free survival
      rate equal to surgical removal of the prostate and may be superior to other
      early stage treatments, with a substantial reduction in the negative side
      effects of impotence and incontinence, frequently associated with surgery and
      external beam radiation treatment. The National Cancer Institute and American
      Cancer Society have reported that sexual impotency after implantation of
      radioactive seeds has been 10 - 30%, which compares with rates of 65 - 90%
      for
      radical prostatectomy and 40 - 60% for external beam radiation therapy. Our
      production method, involving a proprietary dry fabrication process, does not
      use
      radioactive wet chemistry. On July 28, 1999 we received our Radioactive Sealed
      Source Registration Certificate, a Nuclear Regulatory Commission requirement
      administered by the Commonwealth of Massachusetts as a
      Nuclear Regulatory Commission Agreement State. These seeds
      have been on sale in the U.S. for seven years.





*Manufacturing.*Management
      believes that the Company's manufacturing process results in lower capital
      equipment and manufacturing assembly costs and is less hazardous than the
      manufacturing processes used by our competitors. Other radioactive prostate
      seed
      manufacturers use radioactive wet chemistry during seed assembly for Iodine-125
      products. Our dry process, for which we have two patents issued, uses a dry
      fabrication process, and we believe it requires fewer personnel and yields
      faster throughput. Following seed core ion implantation, we send the cores
      to a
      nuclear reactor for activation. Using this dry fabrication process, seed cores
      can be fabricated and inventoried in large quantities and activated only when
      ordered. Due to the short half-life of Iodine-125 (approximately 60 days),
      the
      competition must assemble and ship seeds on a tight schedule so they can be
      implanted into the patient at the appropriate radioactive strength. We maintain
      multiple source vendors for our raw materials supplies in the construction
      of
      our radioactive prostate seeds, including Trace Sciences International, Alfa
      Aesar, Mick Radio Nuclear, Quartz Plus and Braxton Manufacturing.





*Sales.*
      Since August 2003, the
      Company has used its own direct sales force and several independent sales
      representatives to sell prostate seeds to many different
      customers.  In June 2007, the company divested its prostate seed and
      medical software business.





*Treatment
      Planning Software*





*General.*In
      May 2005, Implant
      Sciences acquired proprietary treatment planning technology from Rosses Medical
      Systems, Inc. The Company is investing resources to enhance the capabilities
      of
      this product to include a new module which aids the physician in making 2 and
      3
      dimensional maps of the stage, grade and location of cancer within the prostate
      gland. This “Pathology Mapping ModuleTM”
is in addition
      to
      the standard treatment planning function used for prostate brachytherapy and
      will provide for image guided, focal treatment for the disease. The product
      is
      being marketed as I-PlantTMTPS.





*Sales.*This product was sold by our direct sales force.  This product
      was divested in June, 2007.








5











*Breast
      Cancer Radiation Treatment*




*General*.
      Early stage breast cancer is commonly treated by lumpectomy followed by a course
      of 35 sessions of external beam radiation to the whole breast over a seven
      week
      term. Over the past several years, Accelerated Partial Breast Irradiation (APBI)
      has been increasing in popularity with patients because it can be completed
      in
      four to five days on an outpatient basis and has shown equal efficacy with
      good
      cosmetic outcomes. Approximately 600 to 1,000 patients have already been treated
      using this new temporary brachytherapy technique. Currently this treatment
      is
      performed using a conventional HDR (High Dose Radiation) system using an iridium
      -192 radioactive source. A significant drawback of the currently used iridium
      -192 source is that the treatments must be performed in a heavily concrete
      shielded room to prevent the very penetrating iridium -192 gamma rays
      irradiating people in hallways and adjacent rooms. A very small percentage
      of
      U.S. hospitals currently have such dedicated HDR concrete shielded rooms for
      brachytherapy. The Company has developed a new lower energy source, ytterbium
      -169 which can deliver the same therapeutic dose to the lumpectomy cavity and
      does not require a concrete shielded treatment room. The procedure can be done
      in an ordinary treatment room with some portable shielding around the patient
      using a conventional afterloader system. This source assembly has received
      a
      510(k) pre-market clearance from the FDA and does not require clinical trials
      prior to commercial sales.





*Sales.* We
      expect that the source wires will be
      sold by the manufacturers of the afterloaders or through direct selling efforts.
      This new product will be purchased by the Radiation Oncology Department of
      hospitals which is the same customer our existing prostate seed salesmen call
      on.





*Orthopedic
      Total Joint Replacements*




*General.*We provide surface engineering technology to manufacturers of orthopedic
      hip and knee total joint replacements.  The majority of existing hip and
      knee joint replacements are made of a cobalt chromium femoral component that
      articulates against a polyethylene component.  While offering excellent
      biocompatibility and superior wear resistance over prior alloys and designs
      and
      potentially longer average life than prior alloys, cobalt chromium devices
      still
      suffer from particle generation where the metal and polyethylene components
      articulate against each other.  This particle generation has been
      identified as the primary cause of implant loosening due to osteolysis requiring
      repeat surgery.


**


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




*Manufacturing.*We believe we now operate one of the highest beam-current ion implanters
      used in the medical field.  This equipment has higher throughput and lower
      cost than equipment with a lower beam-current.  For our new
      second-generation orthopedic coating, this equipment can provide a ceramic
      coating with superior characteristics due to its patented “blended interface”
process.  We maintain multiple source vendors for our gas supplies, the
      primary raw material used in the ion implantation process in providing this
      service, including Praxair and Matheson.




*Sales.*We currently implant
      cobalt chromium components of total joint replacements made by our customers
      with nitrogen ions and are developing ceramic ion beam synthesis techniques
      for
      total joint replacements.  We receive untreated cobalt chromium total joint
      replacements from our customers and implant them at our facility.  We then
      invoice and ship the implanted total joint replacements to our
      customers.Sales
      of
      orthopedic coatings declined in 2007 as a major customer changed its
      processing.  We expect this trend to continue in 2008.




*Markets.*Osteoarthritis is a natural result of the aging process and is the
      predominant cause of the need for joint replacement.  We believe that
      longer life expectancy as well as the growth in the number of people over age
      50
      will cause the demand for total joint replacement to increase.  According
      to the American Academy of Orthopedic Surgeons, the hip and knee total
      joint replacement market was estimated to be 650,000 procedures in the United
      States.  Our next generation surface treatment using ion beam synthesized
      ceramic has been shown to decrease wear debris generation by two-thirds, which
      we believe will reduce osteolysis and thereby reduce the need for revision
      surgery.








6








*MicrofusedTM
      Coatings.*





We
      have developed proprietary ion
      assisted coating deposition methods for applying metallic coatings to a variety
      of substrates for uses on medical devices.  The family of processes known
      as MicrofusionTM results in coatings which are biocompatible, extremely dense,
      free of voids, and display tenacious adhesion.  Applications include but
      are not limited to:  (i)   radiopaque coatings used to
      increase the visibility of devices under x-ray or fluoroscopy during
      interventional cardiology and other catheter based procedures, (ii) conductive
      coatings and thin film electrodes used to carry and deliver current to or from
      targeted tissue for use in electrophysiological mapping, neuromodulation, and
      tissue ablation applications, and (iii)  bioceramic coatings
      Nano-hydroxyapatite coatings using Nan-OssTM, Angstrom Medica’s patented
      nanometer sized particulate hydroxyapatite material.  Our
      Nano-hydroxyapatite coating is a hard, glassy, bioceramic that cannot be easily
      scratched off the surface once deposited.  Additionally, engineering
      development services are available to our customers to develop new applications
      of our Microfusion coating technology.








**Marketing
      and Sales**





Our
      marketing and sales methods vary
      according to the characteristics of each of our main business areas. Sales
      and
      marketing to the medical device markets are through our own direct sales force.
      Our semiconductor segment includes implant services and implant diagnostic
      services. Our Vice President, General Manager of Core Systems, along with an
      inside sales staff and several independent sales representatives, are
      responsible for semiconductor ion implantation services, including disk
      refurbishment and source conditioner sales.  Our Vice President of
      Security Products Sales and Marketing is responsible for sales and marketing
      of
      our trace explosives technology, assisted by an inside sales staff and
      international sales reps. The Company uses both inside direct sales personnel
      and independent sales representatives to sell our products. The solicitation
      and
      proposal process for research and development contracts and grants are conducted
      by our President, our Chief Scientist, and our scientific staff.





*Medical
      Sales and Marketing*





To
      promote sales of our radioactive
      prostate seeds and treatment planning systems, we exhibited at various medical
      trade shows, including the American Association of Physicists in Medicine (AAPM)
      show and the American Society for Therapeutics Radiology and Oncology (ASTRO)
      show, which are attended by the vast majority of our potential customers.
      Sales were then concluded by our Director of Brachytherapy Products and
      several independent sales representatives.





In
      the business of ion implantation for
      total joint replacements, we concentrate on identifying and serving leading
      manufacturers. Where possible, we attempt to become the sole provider of devices
      or surface engineering services to each such manufacturer. Our marketing and
      sales efforts require considerable direct contact and typically involve a
      process of customer education in the merits of our technology. We accomplish
      this by first researching customer needs, and through presentations at customer
      sites. Our research and development programs, both independent and in
      conjunction with a customer specific need, as well as our patent portfolio,
      are
      integral components of the marketing process.





To
      promote sales of our MicrofusedTM coatings,
      we
      attend trade shows, use press releases and call customers who we believe have
      an
      application for our technology. Once a customer's interest is established,
      the
      sales process proceeds with an initial demonstration project funded by the
      customer. A set of developmental runs are then performed to determine project
      feasibility and to roughly optimize a parameter set for deposition. After
      testing the samples generated, and considering cost estimates for production
      quantities, the customer may authorize us to proceed to pilot
      production.








7








In
      pilot production, typically, several
      hundred units are produced in a manner equivalent to the envisioned full
      production method. Pilot production may be done on an existing piece of
      equipment with customer/device specific fixturing, or on a prototype machine,
      depending on the complexity of the process and device. Samples made in pilot
      production are fabricated into complete devices and used by the customer for
      further testing, clinical studies, FDA submissions, and marketing and sales
      efforts.





*Semiconductor
      Sales and Marketing*





Since
      semiconductor ion implantation is
      a standard process in all integrated circuit fabrication, customers usually
      know
      what they want and little education is necessary. Our services are promoted
      and
      sold through trade shows, advertising in trade magazines, direct mailings and
      press releases. Most of our specialty implant sales are between $600 and $2,500
      per order and take less than one day to complete. The entire sales effort is
      often conducted by telephone. Our sales range from production customers to
      outsourced customer-specified ion implantation services, which the customer's
      own ion implantation department is unable or unwilling to perform, to small
      research projects. Production implant sales are usually through long-term
      blanket purchase orders where our services are integrated seamlessly into our
      customer’s production line.





*Government
      Contracts*





Research
      and development contracts from
      the U.S. government must be won through a competitive proposal process which
      undergoes peer review. We are in contact with the National Institutes of Health,
      the Department of Defense, the Department of Homeland Security and other
      agencies at technical conferences to stay informed of the government's needs.
      We
      believe our management and senior scientific staff have earned a strong
      reputation with these and other agencies. To date we have been awarded research
      and development contracts by the National Institute of Health, the Department
      of
      Defense, the National Science Foundation, the National Aeronautics and Space
      Administration, the Environmental Protection Agency and the Department of
      Homeland Security.





**Research
      and Development**





Our
      technical staff consists of 13
      scientists and engineers, including three with Ph.D. degrees, and the remaining
      with Masters Degrees, Bachelor Degrees or with expertise in physical sciences
      and engineering. All of our existing and planned products rely on proprietary
      technologies developed in our research and development laboratories. Our
      research and development efforts may be self-funded, funded by corporate
      partners or by awards under the Small Business Innovative Research and other
      programs of the U.S. government. Under the Small Business Innovative Research
      program, we retain the right to patent anything developed pursuant to the
      program, however, the U.S. government retains a royalty free license to use
      the
      technology. We have obtained over $20 million in U.S. government grants and
      contracts over the past 19 years. Each research and development agreement with
      our corporate partners defines the rights to these agreements.





We
      spent approximately $1,844,000,
      $1,313,000 and $1,942,000 on internally funded research and development in
      the
      fiscal years ended June 30, 2007, 2006 and 2005, respectively.





**Patents
      and Proprietary Technology**





It
      is our policy to protect our
      proprietary position by, among other methods, filing United States and foreign
      patent applications. We currently have twenty issued United States patents
      and
      eight United States patent applications pending. Of the twenty patents issued,
      six are of material importance to us and are in the explosives detection. These
      six material patents expire in the years 2021 through 2024.





We
      intend to seek further patents on
      our technologies, if appropriate. However, there can be no assurance that
      patents will be issued for any of our pending or future applications or that
      any
      claim allowed from such applications will be of sufficient scope or strength,
      or
      be issued in all countries where we sell our products and services, to provide
      meaningful protection or any commercial advantage to us.





We
      also rely on unpatented proprietary
      technology, trade secrets and know-how and we do not know if others will
      independently develop substantially equivalent proprietary information,
      techniques or processes, that such technology or know-how will not be disclosed
      or that we can meaningfully protect our rights to such unpatented proprietary
      technology, trade secrets or know-how. Although we have entered into
      non-disclosure agreements with our employees and consultants, we cannot be
      sure
      such non-disclosure agreements will provide adequate protection for our trade
      secrets or other proprietary know-how.








8








**Government
      Regulation and Environmental Matters**





Medical
      devices incorporating our
      technologies, such as interventional cardiology devices are subject to FDA
      regulation. The burden of securing FDA clearance or approval for these core
      business medical devices rests with our customers who use our processes within
      their medical devices.





Since
      the Company divested its prostate
      seed and medical software business in June 2007, the facility will no longer
      be
      a registered medical device manufacturer.  The Company will now only
      supply services and components to medical device manufacturers.





Our
      medical device manufacturing
      facility operates under the FDA QualitySystemRegulation.
      Our facility, located inWakefield,Massachusetts,
      was registered with the FDA in July
      2000 prior to the introduction and commercial sales of our radioactive prostate
      seed product. Our facilitywassubject
      to the FDA’s inspection at any
      time. The FDA has inspected Implant Sciences’ medical manufacturing facilitiesin August 2003,and
      found its Quality
      System to meet their requirements.Implant
      Sciences’ Quality Systems
      Manager ensures adherence to the FDA’s Quality System Regulations as well as to
      the ISO 9001and ISO
      13485standards.





Certain
      activities of ours are
      regulated by, and require approvals from, other federal and state agencies
      such
      as the Massachusetts Department of Public Health, the Department of
      Transportation and the Federal Aeronautics Administration.





In
      order to ship our radioactive
      prostate seed product from our facility, we were required to obtain a
      radioactive sealed source registration from the Massachusetts Department of
      Public Health.  This certificate required no maintenance or renewal as
      long as the design of the radioactive prostate seed was not
      changed.  On July 28, 1999, we received our Radioactive Sealed Source
      Registration Certificate, a Nuclear Regulatory Commission requirement,
      administered by the Commonwealth of Massachusetts as a
      Nuclear Regulatory Commission Agreement State.





The
      State Radiation Control Program
      issued to us a license to manufacture and distribute our radioactive prostate
      seed product.  The State Radiation Control Program performs periodic
      inspections of our facility.  The State Radiation Control Program has
      performed numerous inspections of the facility and identified no violations
      or
      deficiencies.





Furthermore,
      our use, management,
      transportation, and disposal of certain chemicals and wastes are subject to
      regulation by several federal and state agencies depending on the nature of
      the
      chemical or waste material. Certain toxic chemicals and products containing
      toxic chemicals require special reporting to the United States Environmental
      Protection Agency and/or its state counterparts. We are not aware of any
      specific environmental liabilities that we could incur. Our future operations
      may require additional approvals from federal and/or state environmental
      agencies, the cost and effects of which cannot be determined at this
      time.





**Competition**





Many
      medical device manufacturers have developed or are engaged in efforts to develop
      internal surface modification technologies for use on their own products. Most
      companies that market surface modification to the outside marketplace are
      divisions of organizations with businesses in addition to surface modification.
      Many of our existing and potential competitors (including medical device
      manufacturers pursuing coating solutions through their own research and
      development efforts) have substantially greater financial, technical and
      marketing resources than we do.








9








With
      respect to our coating products,
      we primarily compete with Spire Corporation, Ion Bond, LLC, and BryCoat
      Inc.  Competition within the coatings industry is primarily conducted
      on the basis of service and product design. Price competition has abated
      somewhat in the case of first time and more youthful patients where higher-cost
      and more durable reconstructive devices are preferred. We attempt to
      differentiate ourselves from our competition by providing what we believe are
      high value-added solutions to surface modification. We believe that the primary
      factors customers consider in choosing a particular surface modification
      technology are performance, ease of manufacturing, ability to produce multiple
      properties from a single process, compliance with manufacturing regulations,
      customer service, pricing, turnaround time, and the ability to work with a
      variety of materials. We believe that our process competes favorably with
      respect to these factors. We believe that the cost and time required to acquire
      equipment and technical engineering talent, as well as to obtain the necessary
      regulatory approvals, significantly reduces the likelihood of a manufacturer
      changing the coating process it uses after a device has been approved for
      marketing.





Our
      competition in the semiconductor
      industry consists primarily of one company: Innovion Corporation. This company
      is located in San Jose, California and primarily serves the silicon wafer
      production needs of semiconductor factories in their local area. We serve both
      east and west coast factories with silicon production and research and
      development laboratories worldwide.





In
      the trace explosives
      detection industry, General Electric (GE Security) and Smiths Detection are
      our two primary competitors. These two companies also use ion mobility
      spectrometry; however, they use a radioactive 63Ni source
      to ionize
      the explosive molecules. Out technology differs from the competition in that
      we
      do not have a radioactive ion source, we have low operating costs, and can
      do
“real time” detection.    We believe our patented technology
      provides our device with greater operating advantages and less regulatory
      restrictions





Many
      of our competitors and potential
      competitors have substantially greater capital resources than we do and also
      have greater resources and expertise in the areas of research and development,
      obtaining regulatory approvals, manufacturing and marketing. There can be no
      assurance that our competitors and potential competitors will not succeed in
      developing, marketing and distributing technologies and products that are more
      effective than those developed and marketed by us or that would render our
      technology and products obsolete or noncompetitive. Additionally, there is
      no
      assurance that we will be able to compete effectively against such competitors
      and potential competitors in terms of manufacturing, marketing and
      sales.





**Employees**





As
      of June 30, 2007, we had 91 full
      time employees. We believe we maintain good relations with our employees. None
      of our employees are represented by a union or covered by a collective
      bargaining agreement.





**Geographic
      Areas**





The
      majority of the Company’s revenues are derived from domestic sales. During the
      fiscal year ended June 30, 2007, foreign sales represented 31% of total
      revenue. For the fiscal year ended June 30, 2006, foreign sales represented
      26% of revenue with one customer from China representing 17% of the Company’s
      annual revenues.  For fiscal year ended June 30, 2005, foreign sales
      represented less than 10% of total revenue.





**ITEM
      1A.                                RISK
      FACTORS**





This
      Report on Form 10-K contains certain forward-looking statements that are based
      on current expectations. In light of the important factors that can materially
      affect results, including those set forth in this paragraph and below, the
      inclusion of forward-looking information herein should not be regarded as a
      representation by the Company or any other person that the objectives or plans
      of the Company will be achieved. Assumptions relating to budgeting, marketing,
      and other management decisions are subjective in many respects and thus
      susceptible to interpretations and periodic revisions based on actual experience
      and business developments, the impact of which may cause the Company to alter
      its marketing, or other budgets, which may in turn affect the Company's
      financial position and results of operations. The reader is therefore cautioned
      not to place undue reliance on forward-looking statements contained herein,
      which speak solely as of the date of this Form 10-K. The Company assumes no
      responsibility to update any forward-looking statements as a result of new
      information, future events, or otherwise.








10








The
      following factors should be
      considered carefully in evaluating the Company and its business:





**The
      Company has received a modified audit opinion on its ability to continue
      as a going concern.**





The
      audit
      report our independent registered public accounting firm issued on our audited
      financial statements for the fiscal year ended June 30, 2007 contains a
      modification regarding our ability to continue as a going concern. This
      modification indicates that there is substantial doubt on the part of our
      independent registered public accounting firm that we can continue as a going
      concern in that we did not have sufficient cash and liquid assets at June 30,
      2007, to cover our operating capital requirements for the next twelve-month
      period and if sufficient cash cannot be obtained we would have to substantially
      alter our operations, or we may be forced to discontinue operations.  Such
      an opinion from our independent registered public accounting firm may limit
      our
      ability to access certain types of financing, or may prevent us from obtaining
      financing on acceptable terms.  There can be no assurance that the
      auditor will not qualify their opinion in the future.








**We
      do not operate at a profit and do not expect to be profitable for some
      time.**





During
      the twelve months ended June 30, 2007, we had a loss from continuing operations
      of****approximately $9,924,000.  We plan to further
      increase our expenditures to****complete the development and
      commercialization of our new products, and to broaden our sales and marketing
      capabilities. As****a result, we believe that we will likely
      incur losses over the next several****quarters. Our
      accumulated deficit as of June 30, 2007 is approximately
      $47,927,000.





Management
      believes that our existing cash resources, cash proceeds from the sale of
      Accurel, cash from operations and the availability on our revolving line of
      credit will meet working capital requirements over the next twelve
      months.  However, unanticipated decreases in operating revenues,
      unanticipated decreases in the market value of our common stock, delays in
      government funding of grants, increases in expenses or further delays in product
      development may adversely impact our cash position and require further cost
      reductions.  No assurance can be given that we will be able to operate
      profitably on a consistent basis.








**Intense
      competition and rapid technological change could harm our financial
      performance.**




In
      our
      semiconductor market we compete with many companies, including companies that
      have in-house capabilities to implant, diagnose and repair their own
      wafers.  In our explosives detection equipment market, we compete with
      many companies, including companies that have substantially greater capital
      resources, greater research and development, manufacturing and marketing
      resources and experience and greater name recognition than we do. In addition,
      we expect new entrants into our markets.  There can be no assurance that
      our competitors will not succeed in developing or marketing technologies and
      products that are more effective than our products or that would render our
      products obsolete or noncompetitive.




We
      believe that our ability to compete in the explosive detection systems market
      is
      based upon such factors as: product performance, functionality, quality and
      features; quality of customer support services, documentation and training;
      and
      the capability of the technology to appeal to broader applications beyond the
      inspection of passengers, baggage, and cargo carried on airlines. Although
      we
      believe that our currently developed product has all of the capabilities to
      meet
      the United States government’s decree that all passengers, baggage, and cargo
      carried on airlines must be screened thoroughly, certain of our competitors
      may
      have an advantage over our existing technology with respect to these factors.
      There can be no assurance that we will be successful in convincing potential
      customers that our products will be superior to other systems given all of
      the
      necessary performance criteria, that new systems with comparable or greater
      performance, lower price and faster or equivalent throughput will not be
      introduced, or that, if such products are introduced, customers will not delay
      or cancel potential orders for us yet to be commercialized system. Further,
      there can be no assurance that we will be able to bring to commercialization
      and
      further enhance our product to better compete on the basis of cost, throughput,
      accommodation of detection of passengers, baggage or other cargo carried onto
      airlines, or that we will otherwise be able to compete successfully with
      existing or new competitors.




Moreover,
      there can be no assurance that we will be able to price our products and
      services at or below the prices of competing products and technologies in order
      to facilitate market acceptance. Accordingly, our success will depend, in part,
      on our ability to respond quickly to 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 and
      results of operations.







11










**Our
      medical products and technologies may not be accepted by the medical community
      which could harm our financial performance.**




There
      can
      be no assurance that our medical coatings and/or new products 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. There can be no
      assurance that our devices or technologies will be able to replace such
      established treatments or that physicians, health care payers, patients or
      the
      medical community in general will accept and utilize our devices or any other
      medical products that may be developed or treated by us even if regulatory
      and
      reimbursement approvals are obtained. Long-term market acceptance of our
      products and services will depend, in part, on the capabilities, operating
      features and price of our products and technologies as compared to those of
      other available products and services. Failure of our products and technologies
      to gain market acceptance would have a material adverse effect on our business
      and results of operations.




**Our
      explosives detection products and technologies may not be accepted by government
      agencies, airports or airlines which could harm our future financial
      performance.**




There
      can
      be no assurance that our explosives detection systems will achieve wide
      acceptance by the domestic and international airports, government agencies
      and
      airlines, and market acceptance generally. The degree of market acceptance
      for
      our explosives detection products and services will also depend upon a number
      of
      factors, including the receipt and timing of regulatory approvals and the
      establishment and demonstration of the ability of our proposed device to detect
      trace explosives residues on personnel, baggage and other cargo prior to
      embarking on aircraft. Our failure to commercially develop our product to
      compete successfully with respect to throughput, the ability to scan personnel,
      baggage and other cargo carried onto airlines, and portability could delay,
      limit or prevent market acceptance. Moreover, the market for explosives
      detection systems technology, especially trace detection technology, is largely
      undeveloped, and we believe that the overall demand for explosives detection
      systems technology will depend significantly upon public perception of the
      risk
      of terrorist attacks. There can be no assurance that the public will perceive
      the threat of terrorist bombings to be substantial or that the airline industry
      and governmental agencies will actively pursue explosives detection systems
      technology. Long-term market acceptance of our products and services will
      depend, in part, on the capabilities, operating features and price of our
      products and technologies as compared to those of other available products
      and
      services. As a result, there can be no assurance, if the currently developed
      prototype product is brought to a commercial product, that we will be able
      to
      achieve market penetration, revenue growth or profitability.




**Our
      future profitability depends on whether we can successfully develop new products
      and compete in the commercial marketplace.**




We
      currently provide ion implantation services for ion implantation of
      semiconductors and medical devices.  We plan to market radiopaque
      coatings, and explosive detection systems that may require substantial further
      investment in research, product development, preclinical and clinical testing
      and governmental regulatory approvals prior to being marketed and sold. Our
      ability to increase revenues and achieve profitability and positive cash flow
      will depend, in part, on our ability to complete such product development
      efforts, obtain such regulatory approvals, and establish manufacturing and
      marketing programs and gain market acceptance for such proposed
      products.




Our
      product development efforts are subject to the risks inherent in the development
      of such products. These risks include the possibility that development costs
      will be much greater than currently anticipated, that our products will be
      found
      to be ineffective or unsafe, or will otherwise fail to receive necessary
      regulatory approvals; that the products will be difficult to manufacture on
      a
      large scale or be uneconomical to market; that the proprietary rights of third
      parties will interfere with our product development; or that third parties
      will
      market superior or equivalent products which achieve greater market acceptance.
      Furthermore, there can be no assurance that we will be able to conduct our
      product development efforts within the time frames currently anticipated or
      that
      such efforts will be completed successfully.








12








**There
      are risks relating to our Development, Distribution and Manufacturing Agreement
      with Rapiscan Systems, Inc.**





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




In
      March
      2006, the Company brought suit against Rapiscan and its parent, OSI Systems,
      Inc. The Company is requesting rescission of the Agreement, for lack of
      performance and other grounds or in the alternative, termination of the
      Agreement due to material breaches of contract and implied covenant of good
      faith and fair dealing and for damages. Should the Company be unsuccessful
      in
      prosecuting its lawsuit, it could have a material adverse effect on our business
      and results of operations.




In
      March
      2006, the Company received notice that Rapiscan filed a complaint against the
      Company regarding the Agreement. Rapiscan’s complaint is based upon claims of
      breach of contract, breach of warranty and tortuous interference with
      contractual relations and is requesting a decree for specific performance,
      declaratory relief and injunctive relief. Should the Company be unsuccessful
      in
      defending itself in the lawsuit, it could have a material adverse effect on
      our
      business and results of operations.





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





Should
      the Company be unsuccessful in prosecuting this matter, it may have a material
      adverse effect on its business and results of operations.





**We
      own patents, trade secrets and other intellectual property and know-how that
      we
      believe allows us to compete effectively. Limitations on our ability to protect
      our intellectual property or continue to use our intellectual property could
      harm our financial performance.**





Our
      ability to compete effectively will depend, to a significant extent, on our
      ability to operate without infringing the intellectual property rights of
      others. Many participants in the medical device area aggressively seek patent
      protection and have increasing numbers of patents, and have frequently
      demonstrated a readiness to commence litigation based on patent infringement.
      Third parties may assert exclusive patent rights to technologies that are
      important to us.




**Our
      success will depend on our ability to obtain new patents and operate without
      infringing on the proprietary rights of others.**




Although
      we have twenty (20) United States patents issued and eight (8) United States
      patent applications pending for our technology and processes, our success will
      depend, in part, on our ability to obtain the patents applied for and maintain
      trade secret protection for our technology and operate without infringing on
      the
      proprietary rights of third parties. The validity and breadth of claims in
      medical technology patents involve complex legal and factual questions and,
      therefore, may be highly uncertain. No assurance can be given that any pending
      patent applications or any future patent application will issue as patents,
      that
      the scope of any patent protection obtained will be sufficient to exclude
      competitors or provide competitive advantages to us, that any of our patents
      will be held valid if subsequently challenged or that others will not claim
      rights in or ownership of the patents and other proprietary rights held by
      us.


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.





13







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 United States 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.




**If
      we are not successful in managing our future growth, our business will
      suffer.**




We
      have
      limited experience in the commercial production of explosives detection systems.
      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
      bring new products to market,  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
      and results of operations.




**Our
      research and manufacturing activities involve the use of hazardous materials.
      Any liability resulting from the misuse of such hazardous materials could
      adversely affect our business.**




Our
      research and manufacturing 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
      and results of operations.




**Product
      liability claims could damage our reputation and hurt our financial
      results.**




To
      date
      no product liability claims have been asserted against us; however, the testing,
      marketing and sale of implantable devices and materials entail an inherent
      risk
      that product liability claims will be asserted against us, if the use of our
      devices is alleged to have adverse effects on a patient, including exacerbation
      of a patient's condition, further injury, or death. A product liability claim
      or
      a product recall could have a material adverse effect on our business. Certain
      of our devices are designed to be used in treatments of diseases where there
      is
      a high risk of serious medical complications or death.




**If
      our suppliers cannot provide the components or services we require, our ability
      to manufacture our products could be harmed.**




We
      rely
      on a limited number of suppliers to provide materials and services 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 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 and results of operations.







14










**If
      our contract manufacturer cannot provide the services we require, our ability
      to
      manufacture our products could be harmed.**




We
      rely
      on a single contract manufacturer to provide manufacturing services for our
      explosives detection products.  If these services become unavailable,
      we would be required to identify and enter into an agreement with a new contract
      manufacturer or take the manufacturing in house.  The loss of our
      contract manufacturer could significantly disrupt production as well as increase
      the cost of production, thereby also increasing the prices of our
      products.  These changes could have a material adverse effect on our
      business and results of operations.




**If
      we cannot attract and retain the management, sales and other personnel we need,
      we will not be successful.**




There
      is
      intense competition for qualified personnel in the high technology 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, sales 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 and
      results of operations.






**If
      we are unable to complete our assessments as to the adequacy of our internal
      controls over financial reporting as required by Section 404 of the
      Sarbanes-Oxley Act of 2002, investors could lose confidence in the reliability
      of our financial statements, which could result in a decrease in the value
      of
      our common stock.**






As
      directed by Section 404 of the
      Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission adopted
      rules
      requiring public companies to include a report of management on the company's
      internal control over financial reporting in their annual reports on
      Form 10-K. This report is required to contain an assessment by management
      of the effectiveness of such company's internal controls over financial
      reporting. In addition, the independent registered public accounting firm
      auditing a public company's financial statements must attest to and report
      on
      management's assessment of the effectiveness of the company's internal controls
      over financial reporting. While we will begin to   develop the
      necessary documentation and testing procedures required by Section 404,
      there is a risk that we will not comply with all of the requirements imposed
      by
      Section 404. If we fail to implement required new or improved controls, we
      may be unable to comply with the requirements of Section 404 in a timely
      manner. This could result in an adverse reaction in the financial markets due
      to
      a loss of confidence in the reliability of our financial statements, which
      could
      cause the market price of our common stock to decline and make it more difficult
      for us to finance our operations.




In
      our
      report on Form 10-K for the year ended June 30, 2007, our independent auditors
      have reported to our Audit Committee certain matters involving internal controls
      that our independent auditors considered to be a significant deficiency. A
      significant deficiency is a control deficiency or combination of control
      deficiencies, that adversely affects the company’s ability to initiate,
      authorize, record, process, or report external financial data reliably in
      accordance with generally accepted accounting principles such that there is
      more
      than a remote likelihood that a misstatement of the company’s annual or interim
      financial statements that is more than inconsequential will not be prevented
      or
      detected.





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




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





15







We
      cannot assure you that we will
      successfully address the issues raised by our independent auditors
      above.  If we are unable to do so, and a misstatement, error or fraud
      is committed and remains undetected, we may suffer a material adverse effect
      to
      our results of operations.




**Our
      quarterly results may fluctuate significantly, which could adversely affect
      our
      stock price.**




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 commercialization of our new products,
      to increase our manufacturing capacity, to ensure compliance with the Food
      and
      Drug Administration'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 our internal estimates of future demand and not from firm
      customer orders.




**We
      will be required to redeem the Series D Preferred for cash if the five day
      average market price of our common stock, prior to a redemption date, is less
      than 110% of the fixed conversion price.**




We
      will be required to redeem the
      Series D Preferred for cash if the following conditions are not
      met:  (1) the shares must be issued pursuant to an effective
      registration statement, (2) the average closing market price of the common
      stock
      for the five trading days immediately preceding a payment date must exceed
      the
      fixed conversion price of $4.15 by 110% and no one day’s closing price may be
      less than the fixed conversion price, and (3) the conversion dollar value may
      not exceed the aggregate of the prior 22 trading days’ dollar
      volume.  We cannot be certain that we will be able to redeem the
      monthly payment in shares of common stock on a redemption date given the fixed
      conversion price of the preferred stock and the associated market price of
      the
      common stock on a redemption date.  If we are required to redeem
      monthly payments in cash, this will reduce our working capital necessary for
      our
      operations.  Failure of our ability to convert preferred shares into common
      shares will have a material adverse affect on our cash resources.  We may
      be required to reduce or curtail certain operations and research and development
      projects to improve our cash resources.  As of October 11, 2007 the
      closing price of our common stock was $2.03 per share.  As of June 30,
      2007, the outstanding balance is approximately $3,939,000.





**If
      third party credit is unavailable, our working capital could be restricted;
      restrictions on our ability to raise additional capital under certain
      circumstances.**




Currently,
      we rely on cash generated from our operations, private equity financing and
      third party credit for working capital purposes.    If such
      financing is no longer available at acceptable rates, we would be required
      to
      reduce or curtail our operations and research and development
      projects.  This would have a material adverse effect on our business
      and results of operations.




**Shares
      eligible for future sale may adversely affect the market.**




From
      time
      to time, certain of our stockholders may be eligible to sell all or some of
      their shares of common stock by means of ordinary brokerage transactions in
      the
      open market pursuant to Rule 144, promulgated under the Securities Act,
      subject to certain limitations. In general, pursuant to Rule 144, a
      stockholder (or stockholders whose shares are aggregated) who has satisfied
      a
      one year holding period may, under certain circumstances, sell within any three
      month period a number of securities which does not exceed the greater of 1%
      of
      the then outstanding shares of common stock or the average weekly trading volume
      of the class during the four calendar weeks prior to such sale. Rule 144
      also permits, under certain circumstances, the sale of securities, without
      any
      limitation, by our stockholders that are non-affiliates that have satisfied
      a
      two year holding period. Any substantial sale of our common stock pursuant
      to
      Rule 144 or pursuant to any resale prospectus may have material adverse
      effect on the market price of our securities.







16







**Because
      of certain limitation on director/officer liability, our stockholders may have
      limited rights to recover for breach of fiduciary duty.**




As
      permitted by Massachusetts law, our Restated Articles of Organization limit
      the
      liability of our directors for monetary damages for breach of a director's
      fiduciary duty except for liability in certain instances. As a result of our
      charter provision and Massachusetts law, stockholders may have limited rights
      to
      recover against directors for breach of fiduciary duty. In addition, our bylaws
      provide that we shall indemnify our directors, officers, employees and agents
      if
      such persons acted in good faith and reasoned that their conduct was in our
      best
      interest.




**We
      have no history of paying dividends on our common stock.**




We
      have
      never paid any cash dividends on our common stock and do not anticipate paying
      any cash dividends on our common stock in the foreseeable future. We plan to
      retain any future earnings to finance growth. If we decide to pay dividends
      to
      the holders of our common stock, such dividends may not be paid on a timely
      basis.




**The
      anti-takeover provisions of our Restated Articles of Organization and of the
      Massachusetts corporation law may delay, defer or prevent a change of
      control.**




Our
      board
      of directors has the authority to issue up to 5,000,000 shares of preferred
      stock and to determine the price, rights, preferences and privileges and
      restrictions, including voting rights, of those shares without any further
      vote
      or action by our stockholders. The rights of the holders of common stock will
      be
      subject to, and may be harmed by, the rights of the holders of any shares of
      preferred stock that may be issued in the future. The issuance of preferred
      stock may delay, defer or prevent a change in control because the terms of
      any
      issued preferred stock could potentially prohibit our consummation of any
      acquisition, reorganization, sale of substantially all of our assets,
      liquidation or other extraordinary corporate transaction, without the approval
      of the holders of the outstanding shares of preferred stock. In addition, the
      issuance of preferred stock could have a dilutive effect on our
      stockholders.




Our
      stockholders must give substantial
      advance notice prior to the relevant meeting to nominate a candidate for
      director or present a proposal to our stockholders at a meeting. These notice
      requirements could inhibit a takeover by delaying stockholder
      action.





**ITEM
                1B.**
            **UNRESOLVED
                STAFF COMMENTS**





Not
                applicable








**ITEM
                2.**
            **PROPERTIES**





We
      operate out of two separate
      locations. Our corporate offices are located in an approximately 51,000 square
      foot leased facility in Wakefield, Massachusetts. The facility is located
      approximately 15 miles north of Boston in a modern and well maintained business
      park. Our current lease expires in December 2008.  Our current
      facilities are adequate, however, after December 2008 there are various other
      locations available for lease should the Company decide to relocate. In addition
      to our corporate offices, this facility houses all of our research and
      development, brachytherapy manufacturing, as well as semiconductor wafer
      processing.





Our
      second location is in Sunnyvale,
      California, just outside of San Jose. This is where our Core Systems division
      is
      located. We conduct our semiconductor wafer processing and semiconductor
      equipment refurbishing services and sales in an approximately 35,000 square
      foot
      leased facility. This facility, specifically designed to perform semiconductor
      services, is well maintained to ensure the integrity of the product produced.
      This lease expires in December 2009.








17








The
      Company leases a third facility,
      also located in Sunnyvale, CA.  This is the former location of our
      Accurel Systems subsidiary and is being subleased.  This lease expires
      in September 2010.





I**TEM
                3.**
            **LEGAL
                PROCEEDINGS**





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





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





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





On
      March 27, 2006, the Company received
      notice that Rapiscan filed a complaint against the Company and its contract
      manufacturer, Columbia Tech, in the United States District Court for the Central
      District of California, regarding the Rapiscan Agreement. Rapiscan’s complaint
      against the Company is based upon claims of breach of contract and breach of
      warranty and is requesting a decree for specific performance, declaratory relief
      and injunctive relief. Rapiscan’s complaint against Columbia Tech is based upon
      injunctive relief, declaratory relief and tortuous interference with contractual
      relations. On April 12, 2006, Rapiscan dismissed all claims against Columbia
      Tech.





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





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




On
      or about March 8, 2006, the Company
      commenced an arbitration under the Rules of the American Arbitration Association
      against Respondents Majid Ghafghaichi (“Majid”) and Vahe Sarkissisian (“Vahe”),
      seeking a total of $3,994,000 for indemnification of various “Losses,” as
      defined in, and expressly allowed pursuant to, a Stock Purchase Agreement dated
      March 9, 2005 (the “Agreement”), between the Company, as the purchaser, Accurel
      Systems International Corporation (“Accurel), and  Majid and Vahe, as the
      sellers of 100% of the issued and outstanding shares of Accurel
      stock.





More
      specifically, there are four
      claims asserted by the Company against Respondents: (1) Damages of $3.4 million
      resulting from misrepresentations concerning the loss of business from a key
      Accurel customer; (2) unauthorized withdrawals in the amount of approximately
      $276,000 from Accurel by the Respondents prior to the closing; (3) approximately
      $49,000 of disallowed transaction expenses that the Respondents improperly
      received; and (4) undisclosed net liabilities totaling approximately
      $269,000.





Respondents
      have asserted counterclaims
      seeking “an aggregate amount in excess of $1,750,000,” based on the allegedly
“late payment” to Respondents of Company stock and a Secured Promissory Note as
      part of the consideration for their sale of Accurel stock.  The Company has
      filed a detailed denial of all counterclaims.








18








On
      April 11, 2007, the Company and the
      Respondents executed a Settlement and Mutual Release Agreement dismissing the
      claims and counterclaims.  As a result of this settlement, the Company
      recorded a gain of approximately $201,000 as a result of reversing an accrual
      relating to this matter.  This amount is included in the Loss on sale
      of discontinued operations in the Year ended June 30, 2007 Consolidated
      Statements of Operations.





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




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





No
      matters were submitted to a vote of
      security holders during the fourth quarter of fiscal year ended June 30,
      2007.





19





**PART
      II**






**ITEM
                5.**
            **MARKET
                FOR REGISTRANT’S COMMON
                EQUITY AND RELATED STOCKHOLDER
                MATTERS**





**Market
      Price**





As
      of June 30, 2007, our common stock,
      $0.10 par value, was traded on the American Stock Exchange under the symbol
      IMX.
      The following sets forth the range of high and low prices on the American Stock
      Exchange: ****




**High**
            
            
            **Low****Fiscal
                Year Ended June 30, 2006:**Quarter
                ended September 30
            
            $
            9.70
            
            
            $
            2.92Quarter
                ended December 31
            
            $
            6.28
            
            
            $
            3.11Quarter
                Ended March 31
            
            $
            4.65
            
            
            $
            3.38Quarter
                ended June 30
            
            $
            4.07
            
            
            $
            3.07**Fiscal
                Year Ended June 30, 2007:**Quarter
                ended September 30
            
            $
            4.20
            
            
            $
            2.00Quarter
                ended December 31
            
            $
            3.55
            
            
            $
            2.11Quarter
                Ended March 31
            
            $
            2.75
            
            
            $
            1.95Quarter
                ended June 30
            
            $
            2.23
            
            
            $
            1.02





At
      October 11, 2007, the closing sales
      price of our common stock was $2.03 and there were approximately 130
      shareholders of record.




**Equity
      Compensation Plan Disclosure**





The
      following table sets forth certain
      information as of June 30, 2007 regarding securities authorized for issuance
      under our equity compensation plans.




**Plan
                Category**
            
            **Number
                of securities to be issued upon exercise of outstanding options,
                warrants
                and rights**
            
            **Weighted-average
                exercise price of outstanding options, warrants and
                rights**
            
            **Number
                of securities remaining available for future issuance under equity
                compensation plans**Equity
                Compensation Plans Approved by Shareholders
            
            1,790,738
            
            $4.66
            
            660,605Equity
                Compensation Plans Not Approved by Shareholders
            
            -
            
            -
            
            -Total
            
            1,790,738
            
            $4.66
            
            660,605





**Dividends**





We
      have never declared or paid any cash
      dividends on our common stock. We currently anticipate that we will retain
      all
      future earnings for the expansion and operation of our business, and do not
      anticipate paying cash dividends in the foreseeable future.








20








**Sales
      of Unregistered Securities**





On
      December 29, 2006, the Company
      executed a $1.5 million secured term note (the “Note”) payable to
      Laurus.   The Company received $1,500,000 in gross proceeds, less
      a management fee of $60,000 and related transaction costs of approximately
      $500.  The term note is collateralized by substantially all of the
      Company’s assets and two of its subsidiaries, has a 9-month term and bears
      interest at a rate equal to prime plus 1% per annum. The Note contains certain
      restrictive and financial covenants. In connection with the financing, the
      Company issued Laurus a warrant to purchase up to 458,000 shares of the
      Company’s common stock at a price equal to $2.50 per share.  Net cash
      proceeds from this financing were $1,439,500 and were used for general working
      capital.  This Note was paid in full on May 1, 2007, in conjunction
      with the sale of the assets of Accurel Systems.





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




In
      conjunction with this financing, the Company drew from funds available on the
      line of credit and paid in full the outstanding term loan balance of
      approximately $623,000 at Comerica Bank.  In addition, pursuant to the
      terms of the Loan Agreement, the Company converted $1,600,000 of the outstanding
      line of credit balance into a 30 month term note bearing an interest rate at
      the
      prime rate plus one percent (1%) per annum payable in thirty (30) equal monthly
      installments of principal, plus all accrued interest beginning on February
      10,
      2007.   In connection with the financing, the Company issued the
      Bank a warrant to purchase up to 18,939 shares of the Company’s common stock at
      a price equal to $2.64 per share.





All
      of the offers and sales referred to
      above were in private offerings to accredited investors (as such term is defined
      in Regulation D) in reliance upon the exemption provided by Section 4(2) of
      the
      Securities Act and Regulation D promulgated under such act by the Commission.
      Each of the purchasers was furnished with information about us and had the
      opportunity to verify such information. Additionally, we obtained a
      representation from each purchaser of such purchaser's intent to acquire the
      securities for the purpose of investment only, and not with a view toward the
      subsequent distribution thereof. The securities bear appropriate legends and
      we
      have issued stop transfer instructions to our transfer agent.





COMPARATIVE
      STOCK PERFORMANCE




The
      comparative stock performance graph
      below compares the cumulative stockholder return on the Common Stock of Implant
      Sciences Corporation (“IMX”) for the period from July 1, 2002, and through the
      fiscal years ended June 30, 2003, 2004, 2005, 2006 and 2007 with the cumulative
      total return on: (i) the American Stock Exchange Composite Index (the “AMEX”)
      and (ii) a peer group (the “Peer Group”) determined by the Company. The graph
      assumes the investment of $100 in Implant Sciences’ common stock, the AMEX
      Composite Index, and the Peer Group on June 30, 2002, and reinvestment of all
      dividends.  Measurement points are on June 30, 2002, 2003, 2004, 2005, 2006
      and 2007.




The
      Peer Group consists of Isonics
      Corporation, North American Scientific Incorporated, RAE Systems, OSI Systems
      and Ibis Technology Corporation. Management selected the Peer issuers in good
      faith and on an industry or line-of-business basis.





Value
      of $100 investment on June 30,
      2007 at each of the following measurement points.




June
                  30,2002
              2003
              2004
              2005
              2006
              2007IMX
              100
              42
              85
              23
              26
              13AMEX
              100
              108
              139
              172
              214
              262Peer
                  group
              100
              118
              227
              169
              151
              121




21












**ITEM
      6.                      SELECTED FINANCIAL
      DATA**





The
      selected financial data presented
      below is derived from our consolidated financial statements and should be read
      in connection with those statements.





**Year
                ended June 30,******
            **2007***
            
            
            ****
            **2006***
            
            
            **2005**
            
            
            **2004**
            
            
            **2003****Consolidated
                Statements of Operations Data:**Revenues
            
            $
            15,432,000
            
            
            $
            18,074,000
            
            
            $
            10,012,000
            
            
            $
            8,566,000
            
            
            $
            6,696,000Cost
                of revenue
            
            
            13,455,000
            
            
            
            16,455,000
            
            
            
            10,537,000
            
            
            
            6,186,000
            
            
            
            5,363,000Research
                and development
            
            
            1,844,000
            
            
            
            1,313,000
            
            
            
            1,942,000
            
            
            
            1,631,000
            
            
            
            1,776,000Selling,
                general and administrative
            
            
            6,578,000
            
            
            
            7,300,000
            
            
            
            4,972,000
            
            
            
            4,599,000
            
            
            
            2,326,000Impairment
                of goodwill and long lived assets
            
            
            3,829,000
            
            
            
            457,000
            
            
            
            -
            
            
            
            -
            
            
            
            -Other
                income (expense)
            
            
            232,000
            
            
            
            (654,000
            )
            
            
            (134,000
            )
            
            
            (162,000
            )
            
            
            -Loss
                from continuing operations
            
            
            (9,924,000
            )
            
            
            (8,105,000
            )
            
            
            (7,573,000
            )
            
            
            (4,012,000
            )
            
            
            (2,769,000
            )Preferred
                distribution
            
            
            (951,000
            )
            
            
            (1,089,000
            )
            
            
            (1,183,000
            )
            
            
            (2,527,000
            )
            
            
            (891,000
            )Loss
                from continuing operations available to common
                shareholders
            
            
            (10,875,000
            )
            
            
            (9,194,000
            )
            
            
            (8,756,000
            )
            
            
            (6,539,000
            )
            
            
            (3,660,000
            )Income
                (loss) from discontinued operations
            
            
            (764,000
            )
            
            
            1,021,000
            
            
            
            168,000
            
            
            
            -
            
            
            
            -Net
                loss applicable to common shareholders
            
            $
            (11,639,000
            )
            
            $
            (8,173,000
            )
            
            $
            (8,588,000
            )
            
            $
            (6,539,000
            )
            
            $
            (3,660,000
            )Loss
                per share from continuing operations applicable to common shareholders,
                basic and diluted
            
            $
            (0.92
            )
            
            $
            (0.81
            )
            
            $
            (0.93
            )
            
            $
            (0.89
            )
            
            $
            (0.58
            )Net
                loss per share applicable to common shareholders, basic and
                diluted
            
            $
            (0.99
            )
            
            $
            (0.72
            )
            
            $
            (0.91
            )
            
            $
            (0.89
            )
            
            $
            (0.58
            )Weighted
                average common shares outstanding used in computing basic and diluted
                loss
                per share
            
            
            11,794,599
            
            
            
            11,325,842
            
            
            
            9,412,548
            
            
            
            7,317,677
            
            
            
            6,310,748*FAS
                123(R) was in effect







22





**June
                30,****2007**
            
            
            **2006**
            
            
            **2005**
            
            
            **2004**
            
            
            **2003****Consolidated
                Balance Sheet Data:**Cash
                and cash equivalents
            
            $
            9,621,000
            
            
            $
            2,074,000
            
            
            $
            1,323,000
            
            
            $
            6,906,000
            
            
            $
            959,000Working
                capital (deficit)
            
            
            9,089,000
            
            
            
            2,259,000
            
            
            
            (764,000
            )
            
            
            8,253,000
            
            
            
            (272,000
            )Goodwill
            
            
            2,062,000
            
            
            
            4,091,000
            
            
            
            4,641,000
            
            
            
            -
            
            
            
            -Total
                assets
            
            
            19,600,000
            
            
            
            30,799,000
            
            
            
            32,228,000
            
            
            
            15,224,000
            
            
            
            7,297,000Total
                liabilities
            
            
            6,165,000
            
            
            
            8,303,000
            
            
            
            8,844,000
            
            
            
            2,054,000
            
            
            
            2,703,000Preferred
                stock
            
            
            2,989,000
            
            
            
            2,568,000
            
            
            
            -
            
            
            
            670,000
            
            
            
            966,000Total
                stockholders' equity
            
            $
            10,446,000
            
            
            $
            19,928,000
            
            
            $
            23,384,000
            
            
            $
            12,500,000
            
            
            $
            3,628,000





**Quarterly
                Financial Data****Fiscal
                2007 Quarter Ended *****September
                30**
            
            
            **December
                31**
            
            
            **March
                31**
            
            
            **June
                30 (1)**Revenues
            
            $
            3,264,000
            
            
            $
            4,858,000
            
            
            $
            3,916,000
            
            
            $
            3,394,000Gross
                margin (deficit)
            
            
            199,000
            
            
            
            933,000
            
            
            
            721,000
            
            
            
            124,000Loss
                from operations
            
            
            (1,855,000
            )
            
            
            (1,143,000
            )
            
            
            (1,145,000
            )
            
            
            (6,013,000
            )Loss
                from continuing operations
            
            
            (1,976,000
            )
            
            
            (521,000
            )
            
            
            (1,541,000
            )
            
            
            (5,886,000
            )Income
                (loss) from discontinued operations
            
            
            366,000
            
            
            
            124,000
            
            
            
            (628,000
            )
            
            
            (626,000
            )Net
                loss applicable to common shareholders
            
            
            (1,846,000
            )
            
            
            (542,000
            )
            
            
            (2,169,000
            )
            
            
            (7,082,000
            )Net
                loss per common share
            
            $
            (0.16
            )
            
            $
            (0.05
            )
            
            $
            (0.18
            )
            
            $
            (0.60
            )Weighted
                average shares outstanding
            
            
            11,763,574
            
            
            
            11,768,986
            
            
            
            11,784,427
            
            
            
            11,835,661(1)
                Quarter ending June 30, 2007 includes $3,829,000 of impairment of
                goodwill
                and long lived assets





**Fiscal
                2006 Quarter Ended *****September
                30**
            
            
            **December
                31**
            
            
            **March
                31**
            
            
            **June
                30**Revenues
            
            $
            2,875,000
            
            
            $
            5,573,000
            
            
            $
            4,424,000
            
            
            $
            5,202,000Gross
                margin (deficit)
            
            
            (564,000
            )
            
            
            839,000
            
            
            
            368,000
            
            
            
            976,000Loss
                from operations
            
            
            (2,444,000
            )
            
            
            (1,892,000
            )
            
            
            (1,366,000
            )
            
            
            (1,749,000
            )Loss
                from continuing operations
            
            
            (2,547,000
            )
            
            
            (1,123,000
            )
            
            
            (1,471,000
            )
            
            
            (2,964,000
            )Net
                income from discontinued operations
            
            
            180,000
            
            
            
            190,000
            
            
            
            206,000
            
            
            
            445,000Net
                loss applicable to common shareholders
            
            
            (2,367,000
            )
            
            
            (1,320,000
            )
            
            
            (1,655,000
            )
            
            
            (2,831,000
            )Net
                loss per common share
            
            $
            (0.21
            )
            
            $
            (0.12
            )
            
            $
            (0.15
            )
            
            $
            (0.24
            )Weighted
                average shares outstanding
            
            
            10,962,703
            
            
            
            11,379,275
            
            
            
            11,379,275
            
            
            
            11,582,115





*FAS
      123(R) was in effect








23





**ITEM
                7.**
            **MANAGEMENT’S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
                OPERATIONS**




**OVERVIEW**




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





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




On
      October 15, 2004,
      the Company acquired Core Systems Incorporated (“Core”).   The
      result of operations for the acquired company is included in the Company’s
      results of operations since the date of acquisition. As such, the results of
      operations for the years ended June 30, 2007, 2006 and 2005 are not
      comparable.




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








**RESULTS
      OF OPERATIONS**





The
      following is a discussion and
      analysis of the financial condition and results of operation of the Company
      for
      the years ended June 30, 2007, 2006 and 2005. It should be read in conjunction
      with the financial statements and notes thereto appearing elsewhere
      herein.





*Revenues.*
      Total revenues for
      the year ended June 30, 2007 were $15,432,000 as compared to $18,074,000 and
      $10,012,000 for the prior year periods ended June 30, 2006 and 2005,
      respectively. Our revenues by business segment are as follows:





**Year
                EndedJune
                30, 2007****Medical**
            **Semiconductor**
            **Security**
            **Total**$3,976,000
            $6,874,000
            $4,582,000
            $15,432,000**Year
                Ended June 30, 2006****Medical**
            **Semiconductor**
            **Security**
            **Total**$4,464,000
            $6,739,000
            $6,871,000
            $18,074,000**Year
                Ended June 30, 2005****Medical**
            **Semiconductor**
            **Security**
            **Total**$4,146,000
            $4,356,000
            $1,510,000
            $10,012,000







24






Revenues
      for
      the year ended June 30, 2007 were $15,432,000 as compared to $18,074,000 in
      the
      year ended June 30, 2006, a decrease of $2,642,000 or
      15%.   Revenues in the Security products business segment were
      $4,582,000  for the year ended June 30, 2007 as compared to $6,871,000
      for the prior year, a decrease of $2,289,000 or 33%.  This decrease is
      the result of the completion and shipment of a significant order of the
      Company’s explosive detection equipment to a customer in China in the comparable
      prior year period.  The Company has not realized an order of the same
      magnitude as it had in the year ended June 30, 2006.  The lack of
      sizeable unit orders has been partially offset by the award and performance
      of a
      new government contract in the explosive detection arena.  Revenues in
      the Medical segment were $3,976,000 for the year ended June 30, 2007 as compared
      to $4,464,000 in the same prior year period, a decrease of $488,000, or
      11%.  This decrease is primarily due to the loss of the Company’s
      primary orthopedics coatings customer during the second quarter of
      2007.  Revenues in the Semiconductor business segment were $6,874,000
      for the year ended June 30, 2007, as compared to $6,739,000 for the prior year,
      an increase of $135,000, or 2%.  This increase is due to a slight
      increase in Krytek source conditioner unit sales.  Fiscal 2006 was the
      first year that revenues from Core were included for the full fiscal year.
      Core
      was acquired on October 15, 2004.




Total
      revenues for the year ended June 30, 2006 were $18,074,000 as compared to
      $10,012,000 in the year ended June 30, 2005 an increase of $8,062,000 or 81%.
      The increase is primarily attributable to increases in our Security products
      business line combined with an increase in revenues from Core since their
      acquisition on October 15, 2004. The increase in Security products revenue
      is
      primarily attributable to the first significant commercial quantities of our
      hand held explosive detection devices being sold in fiscal 2006 and from the
      performance of a significant government contract granted by the Transportation
      Security Administration.  Revenues from Core totaled approximately
      $5,115,000 for the year ended June 30, 2006 and $3,564,000 for the year ended
      June 30, 2005. Core is included in our semiconductor
      segment.  Revenues in our Medical business segment were $4,464,000 for
      the 2007 fiscal year as compared to $4,146,000 for the 2006 fiscal year, an
      increase of $318,000, or 8%.  This increase is primarily from our
      Seeds business and associated treatment planning systems.




*Cost
      of
      Revenues*. Cost of revenues for the year ended June 30, 2007 was $13,455,000
      as compared to $16,455,000 and $10,537,000 for the prior year periods ended
      June
      30, 2006 and 2005, respectively. The cost of revenues by business segment is
      as
      follows:





**Year
                Ended June 30, 2007****Medical**
            **Semiconductor**
            **Security**
            **Total**$3,717,000
            $6,406,000
            $3,332,000
            $13,455,000**Year
                Ended June 30, 2006****Medical**
            **Semiconductor**
            **Security**
            **Total**$3,869,000
            $6,364,000
            $6,222,000
            $16,455,000**Year
                Ended June 30, 2005****Medical**
            **Semiconductor**
            **Security**
            **Total**$3,821,000
            $4,797,000
            $1,919,000
            $10,537,000








Total
      cost of revenues for the year
      ended June 30, 2007 were $13,455,000 as compared to $16,455,000 for the prior
      year period, a decrease of $3,000,000 or 18%.  Cost of revenues for
      our security products segment was $3,332,000 for the year ended June 30, 2007
      as
      compared to $6,222,000 for the prior year period, a decrease of $2,890,000,
      or
      46%.  This decrease is primarily due to the variable costs associated
      with the delivery of a significant order of hand held explosive detectors in
      the
      comparable prior year period.  Cost of revenues for our Semiconductor
      business segment were $6,406,000 for the year ended June 30, 2007 as compared
      to
      $6,364,000 for the prior year period, a $42,000 increase, or 1%.  This
      slight increase is primarily due to the 2% increase in Semiconductor
      revenues.   Cost of revenues for our Medical business segment
      were $3,717,000 for the year ended June 30, 2007 as compared to $3,869,000
      for
      the prior year period, a $152,000 decrease, or 4%.  This decrease in
      cost is primarily related to the decreased sales levels in the Medical group
      related to the loss of the Company’s major orthopedics coating customer in the
      second quarter of 2007 which in turn reduced direct labor costs.





25




Total
      cost of revenues for the year ended June 30, 2006 were $16,455,000 as compared
      to $10,537,000 for the prior year period, an increase of $5,918,000 or 56%.
      Cost
      of revenues for our Semiconductor business segment was $6,364,000 for the year
      ended June 30, 2006 as compared to $4,797,000 for the prior year period, an
      increase of $1,567,000 or 33%. Fiscal year 2006 was the first year that the
      results of Core were included in our operations for a full fiscal year. Core
      was
      acquired on October 15, 2004. Cost of revenues for Core were $4,497,000 for
      the
      year ended June 30, 2006 as compared to $3,045,000 for the prior year, an
      increase of $1,452,000 or 48%. Cost of revenues for our security products
      segment was $6,222,000 for the year ended June 30, 2006 as compared to
      $1,919,000 for the prior year period. Most of the increase is attributable
      to
      materials and manufacturing costs associated with the sales of our hand held
      explosives detection devices.





*Gross
      Margins*





**Year
                ended June 30, 2007****Medical**
            
            
            **Semiconductor**
            
            
            **Security**
            
            
            **Total**Sales
            
            $
            3,976,000
            
            
            $
            6,874,000
            
            
            $
            4,582,000
            
            
            $
            15,432,000COS
            
            $
            3,717,000
            
            
            $
            6,406,000
            
            
            $
            3,332,000
            
            
            $
            13,455,000Margin
                %
            
            
            7
            %
            
            
            7
            %
            
            
            27
            %
            
            
            13
            %**Year
                ended June 30, 2006****Medical**
            
            
            **Semiconductor**
            
            
            **Security**
            
            
            **Total**Sales
            
            $
            4,464,000
            
            
            $
            6,739,000
            
            
            $
            6,871,000
            
            
            $
            18,074,000COS
            
            $
            3,869,000
            
            
            $
            6,364,000
            
            
            $
            6,222,000
            
            
            $
            16,455,000Margin
                %
            
            
            13
            %
            
            
            6
            %
            
            
            9
            %
            
            
            9
            %**Year
                ended June 30, 2005****Medical**
            
            
            **Semiconductor**
            
            
            **Security**
            
            
            **Total**Sales
            
            $
            4,146,000
            
            
            $
            4,356,000
            
            
            $
            1,510,000
            
            
            $
            10,012,000COS
            
            $
            3,821,000
            
            
            $
            4,797,000
            
            
            $
            1,919,000
            
            
            $
            10,537,000Margin
                %
            
            
            8
            %
            
            
            (10
            %)
            
            
            (27
            %)
            
            
            (5
            %)








Overall
      gross margins were 13% of
      revenues in the year ended June 30, 2007 as compared to 9% in the prior
      year.  Our Medical products business segments gross profit percentage
      was 7% for the year ended June 30, 2007 as compared to 13% for the same prior
      year period.  This decrease in gross profit percentage is a result of
      the Company losing its major orthopedics coating customer which generally had
      higher gross margins than our other Medical products.  The
      Semiconductor segment’s gross margin slightly improved from 6% to 7% which was
      partially due to having sold more Krytek source conditioning units in the
      current year than in the prior year.  Krytek units generally have a
      higher gross margin than our other semiconductor products and
      services.  The improvement from a 9% gross margin to a 27% gross
      margin in the Security products segment is due primarily to the elimination
      of
      handheld explosives detection device manufacturing costs.  While the
      gross margins were positive for the first three quarters of fiscal 2007, the
      Company recognized a negative gross margin in Q4 primarily as a result of a
      decline in government contract billings combined with a decline in semiconductor
      revenue.  Technical resources were focused on internally funded
      projects in Q4, which reduced the amount of government contract revenue
      recognized,  In addition, certain pieces of semiconductor equipment
      located in the Wakefield facility were dismantled and relocated to Sunnyvale,
      CA, which impacted the revenue.  During the year ended June 30, 2007,
      all manufacturing was conducted by a contract manufacturer allowing the Company
      to reduce its manufacturing overhead.





Overall
      gross margins were 9% of
      revenues in the year ended June 30, 2006 as compared to a gross margin loss
      of
      5% in the prior year. The increase in gross margins comes from all of our
      business segments.  Security products gross margins were 9% for the
      year ended June 30, 2006 as compared to a gross margin loss of 27% in the prior
      year period. The improvement in security products margin is due to the
      manufacturing and sale of handheld trace explosives detection devices which
      covered the cost of our manufacturing organization built during the prior year.
      Once the initial handheld explosives detector production run was completed,
      and
      the manufacturing process was proven, manufacturing was transitioned to a
      contract manufacturer allowing the Company to reduce its manufacturing overhead.
      The medical segment gross margins were 13% for the year ended June 30, 2006
      compared to 8% for the prior year period. The improvement in gross margin came
      from manufacturing efficiencies gained in our seeds operations primarily from
      increased volumes and cost reductions. Semiconductor gross margins were 6%
      for
      the year ended June 30, 2006 as compared to a gross margin loss of 10% for
      the
      prior year period.  This improvement is partially due to an increase
      in Krytek source conditioning revenues, which generally have a higher gross
      margin than our other Semiconductor products.






26




*Research
      and Development*.
      Research and development expense for the year ended June 30, 2007 was $1,844,000
      as compared to $1,313,000 for the prior year, an increase of $531,000 or
      40%.  The Company continues to expend funds to further the development
      of new products in the area of explosives and toxic substance
      detection.  In addition, the increase in research and development
      expenses relates to the volume and timing of customer funded programs, primarily
      through government grants and contracts.  The Company charges its
      research and development personnel to cost of revenues for work performed on
      these contracts and grants.  Research and development expenses prior
      to starting the government contracts are charged to operating
      expenses.





Research
      and development expense for the year ended June 30, 2006 was $1,313,000 as
      compared to $1,942,000 for the comparable prior year period, a decrease of
      $629,000, or 32%. These expenses include $122,000 and $241,000 of stock-based
      compensation expense, respectively. The decrease in research and development
      expenses relates to the increase in customer funded programs, primarily through
      government grants and contracts, performed in fiscal 2006. The Company charges
      its research and development personnel to cost of revenues for work performed
      on
      these contracts and grants. A total of $692,000 of research and development
      personnel costs were charged to cost of sales in the year ended June 30, 2006
      as
      compared to $459,000 in the prior year period. In addition, other costs
      associated with unfunded research and development projects in the prior fiscal
      year were expensed to research and development.





*Selling,
      General and
      Administrative*.  Selling, general and administrative expense for
      the year ended June 30, 2007 was $6,578,000 as compared to $7,300,000 for the
      comparable prior year period, a decrease of $722,000, or 10%.  The
      decrease is primarily due to a reduction in stock based compensation and
      commission expense paid in conjunction with the sale of our handheld explosive
      detection equipment combined with a decrease in outside consulting
      expenses.





Selling,
      general and administrative expense for the year ended June 30, 2006 was
      $7,300,000 as compared to $4,972,000 for the comparable prior year period,
      an
      increase of $2,328,000, or 47%. This increase is partially related to $532,000
      of additional selling, general and administrative expenses incurred due to
      the
      inclusion of Core for the full twelve month period in fiscal 2006. Core was
      acquired on October 15, 2004 and the prior year includes their costs from the
      day of acquisition. Selling, general and administrative also included $1,572,000
      of share based compensation, measured at fair value, due to the adoption of
      SFAS
      123R “Accounting for Stock-Based Compensation (“SFAS 123R”) in fiscal 2006 as
      compared to $135,000 of non-cash stock based compensation in the prior year
      period measured at fair value. During the years ended June 30, 2007 and 2006,
      the Company also recorded $3,829,000 and $457,000, respectively, of impairment
      charges to write down goodwill and long lived assets associated with the
      acquisition of Core.





*Other
      Income and Expenses,
      Net*. For the year ended June 30, 2007, the Company recorded other income,
      net, of $232,000 as compared to $654,000 of other expense, net, in the
      comparable prior year period, a net benefit of $886,000.  The net
      benefit realized in 2007 as compared to 2006 is primarily due to
      a $1,294,000 loss recorded in 2006 on the modification of the Series D
      Redeemable Convertible Preferred Stock, accounted for as an extinguishment
      of
      debt under EITF 96-19.  In the year ended June 30, 2007, the Company
      recorded a loss of $158,000 representing the Company’s share of losses
      attributable to its investment in CorNova, an unconsolidated subsidiary
      accounted for under the equity method of accounting, as compared to a loss
      of
      $359,000 for the comparable prior year period.  Other income and
      expense also includes a $961,000 gain due to the change in the value of the
      embedded derivatives associated with the Series D Redeemable Convertible
      Preferred Stock.  Interest expense for the year ending June 30, 2007
      was $656,000 as compared to $168,000 for the year ending June 30, 2006, an
      increase of $488,000.  The increase in interest expense is primarily
      due to interest related to a short-term note with Laurus along with interest
      related to a financing arrangement with Bridge Bank that both began during
      2007.




For
      the year ended June 30, 2006, the
      Company recorded other expense, net, of $654,000 as compared to $134,000, in
      the
      comparable prior year period an increase of $520,000 or 388%. Other income
      and
      expense includes a loss of $359,000 representing the Company’s share of losses
      attributable to its investment in CorNova, an unconsolidated subsidiary
      accounted for under the equity method of accounting. Other income and expense
      also includes a $1,121,000 gain due to the change in the value of the embedded
      derivatives associated with the Series D Redeemable Convertible Preferred Stock,
      since its issuance on September 30, 2005, and a loss on the modification of
      the
      Series D Redeemable Convertible Preferred Stock, accounted for as an
      extinguishment of debt under EITF 96-19 of $1,294,000.




27


*Loss
      from continuing operations.*Loss from continuing operations for
      the year ended June 30, 2007 was $9,924,000 as compared to $8,105,000 for the
      comparable prior year period, an increase 1,819,000, or 22%.  The
      increase in net loss is primarily due to a $3,829,000 impairment charge
      related to goodwill and long lived assets on the acquisition of Core, which
      was
      partially offset by a $1,294,000 loss recorded in 2006 on the modification
      of
      the Series D Redeemable Convertible Preferred Stock, combined with the overall
      improvement in gross margins and with lower equity losses related to the
      Company’s investment in CorNova *.*





Loss
      from
      continuing operations for the year ended June 30, 2006 was $8,105,000 as
      compared with $7,573,000 for the comparable prior year period, an increase
      in
      net loss of $532,000, or 7%. The increase in net loss is primarily due to a
      $2,156,000 increase in operating expenses combined with a $520,000 increase
      in
      other expenses which was partially offset by an increase in gross margin of
      $2,144,000.  The fiscal 2006 net loss includes $2,234,000 of SFAS 123R
      share-based compensation and other non-cash compensation compared to $378,000
      of
      non-cash compensation in the prior year period. The Company adopted FAS123R
      in
      the 2006 fiscal year using the modified prospective method.





Preferred
      distribution, dividends and accretion on Series D Redeemable Convertible
      Preferred Stock were $951,000 in the year ended June 30, 2007 as compared to
      $1,089,000 in the comparable prior year period.  The Company issued
      Series D Redeemable Convertible Preferred Stock on September 30, 2005. All
      previous issues of preferred stock had been converted to common in the prior
      year period.





Preferred
      distribution, dividends and accretion on Series D Redeemable Convertible
      Preferred Stock were $1,089,000 in the year ended June 30, 2006 as compared
      to
      $1,183,000 in the year ended June 30, 2005. The Company issued Series D
      Redeemable Convertible Preferred Stock on September 30, 2005. All previous
      issues of preferred stock had been converted to common in the prior year
      period.





*Income
      (Loss) From Discontinued
      Operations.*Netlossfrom
      discontinued operationsfor the year ended
      June30, 2007 was $764,000
      as compared to net income of $1,021,000 in the comparable prior year
      period.  On May 1, 2007, the Company entered into an Asset Purchase
      Agreement to sell substantially all of the assets of its subsidiary, Accurel
      Systems International Corporation to Evans Analytical Group LLC.  The
      proceeds from the sale of the assets of Accurel, less related transaction costs,
      were less than the book value of the net assets transferred, and therefore
      a
      loss on sale of $1,246,000 was recorded during the year ended June 30,
      2007.








**LIQUIDITY
      AND CAPITAL RESOURCES**





**Year
                Ended June 30,****2007**
            
            
            **2006**
            
            
            **2005**Cash
                and cash equivalents
            
            $
            9,621,000
            
            
            $
            2,074,000
            
            
            $
            1,549,000Cash
                used in continuing operations
            
            
            (3,329,000
            )
            
            
            (3,377,000
            )
            
            
            (3,954,000
            )Cash
                provided by discontinued operations
            
            
            845,000
            
            
            
            1,048,000
            
            
            
            625,000Net
                cash used in operating activities
            
            
            (2,484,000
            )
            
            
            (2,329,000
            )
            
            
            (3,329,000
            )Cash
                provided by (used in) continuing operations
            
            
            9,446,000
            
            
            
            (535,000
            )
            
            
            (9,608,000
            )Cash
                provided by (used in) discontinued operations
            
            
            (121,000
            )
            
            
            (117,000
            )
            
            
            1,391,000Net
                cash provided by (used) in investing activities
            
            
            9,325,000
            
            
            
            (652,000
            )
            
            
            (8,217,000
            )Cash
                provided by (used in) continuing operations
            
            
            (138,000
            )
            
            
            3,883,000
            
            
            
            7,401,000Cash
                provided by (used in) discontinued operations
            
            
            844,000
            
            
            
            (377,000
            )
            
            
            (1,212,000
            )Net
                cash provided by financing activities
            
            
            706,000
            
            
            
            3,506,000
            
            
            
            6,189,000Net
                increase (decrease) in cash and cash equivalents
            
            $
            7,547,000
            
            
            $
            525,000
            
            
            $
            (5,357,000
            )








28





As
      of June 30, 2007, the Company had
      approximately $9,621,000 in the form of cash and cash equivalents. During the
      year ended June 30, 2007, operating activities used cash of approximately
      $2,484,000.  Net cash used by operating activities primarily reflects the
      net loss from continuing operations of $9,924,000, a loss from discontinued
      operations of $764,000, and a change in the value of derivatives of
      $961,000.  The Company has approximately $688,000 of raw materials and
      finished goods inventories related to its handheld explosives detection
      product.  This inventory was built in anticipation of future shipments
      of this product to customers.  Orders for the explosives detection
      product to date have typically been from foreign governments or agencies of
      foreign governments.  The sales cycle to these entities can take a
      number of months to; close the order, set up letters of credit from the customer
      covering the payment, and obtain the necessary export licenses and other
      required documentation.  Expected future shipments of these products,
      in the near term, can be accomplished with no further investment in inventories
      and current levels of inventory are expected to decrease.  Investing
      activities provided $9,325,000 of cash primarily due to the net proceeds of
      $10,521,000 related to the sale of our Accurel subsidiary, partially offset
      by
      $1,000,000 that was placed in escrow related to the sale of Accurel, and by
      $333,000 used for investment in property and equipment.  Financing
      activities provided cash of $706,000 and consist primarily of $1,500,000 of
      proceeds from a note from Laurus, $1,600,000 in proceeds in a note from Bridge
      Bank, partially offset by $2,914,000 in payments on bank loans, lines of credit
      and capital leases.





On
      December 29, 2006, the Company executed a $1.5 million secured term note (the
      “Note”) payable to Laurus.   The Company received $1,500,000 in
      gross proceeds, less a management fee of $60,000 and related transaction costs
      of approximately $500.  The term note was collateralized by
      substantially all of the Company’s assets and two of its subsidiaries, has a
      9-month term and bears interest at a rate equal to prime plus 1% per annum.
      The
      Note contains certain restrictive and financial covenants. In connection with
      the financing, the Company issued Laurus a warrant to purchase up to 458,000
      shares of the Company’s common stock at a price equal to $2.50 per
      share.  Net cash proceeds from this financing were $1,439,500 and were
      used for general working capital.  This Note was paid in full on May
      1, 2007, in conjunction with the sale of the assets of Accurel
      Systems.





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




In
      conjunction with this financing, the Company drew from funds available on the
      line of credit and paid in full the outstanding term loan balance of
      approximately $623,000 at Comerica Bank.  In addition, pursuant to the
      terms of the Loan Agreement, the Company converted $1,600,000 of the outstanding
      line of credit balance into a 30 month term note bearing an interest rate at
      the
      prime rate plus one percent (1%) per annum payable in thirty (30) equal monthly
      installments of principal, plus all accrued interest beginning on February
      10,
      2007.   In connection with the financing, the Company issued the
      Bank a warrant to purchase up to 18,939 shares of the Company’s common stock at
      a price equal to $2.64 per share.





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





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





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






29





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





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





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





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





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





**Debt
                and Capital Lease(1)**
            
            
            **Operating
                Lease(1)(2)**
            
            
            **MED-TEC**
            
            
            **Total**2008
            
            $
            2,230,000
            
            
            $
            1,461,000
            
            
            $
            207,000
            
            
            $
            3,898,0002009
            
            
            3,041,000
            
            
            
            1,201,000
            
            
            
            -
            
            
            
            4,242,0002010
            
            
            15,000
            
            
            
            578,000
            
            
            
            -
            
            
            
            593,0002011
            
            
            2,000
            
            
            
            84,000
            
            
            
            -
            
            
            
            86,000Total
            
            $
            5,288,000
            
            
            $
            3,324,000
            
            
            $
            207,000
            
            
            $
            8,819,000




(1)
      Payments include interest


(2)  Adjusted
      for sublease






30





*Critical
      Accounting Policies*




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





The
      Company has identified the following as critical accounting policies, based
      on
      the significant judgments and estimates used in determining the amounts reported
      in its financial statements:




§
            *Revenue
                Recognition - Product and Government Contract
                Revenues*




The
      Company recognizes revenue when there is persuasive evidence of an arrangement
      with the customer which states a fixed or determinable price and terms, delivery
      of the product has occurred or the service performed in accordance with the
      terms of the arrangement, and collectibility of the sale is reasonably
      assured.





Government
      contract revenue under cost-sharing research and development agreements is
      recognized as eligible research and development expenses are incurred. The
      Company’s obligation with respect to these agreements is to perform the research
      on a best-efforts basis. For government contracts with a deliverable, revenue
      is
      recognized based upon the proportional performance method.





Revenues
      for which the Company has received payment, but has not yet recognized the
      revenues, pending fulfilling its obligations under the sales agreement, are
      reflected on the balance sheet as deferred revenues.





Treatment
      systems planning revenues consists of sales of software licenses and maintenance
      agreements, product related training, installation, and consulting, and the
      associated hardware. Revenue from sales of software licenses and maintenance
      agreements is recognized ratably over the maintenance contract period, which
      is
      generally one year, pursuant to the guidance provided by Statement of Position
      (“SOP”) 97-2, “*Software Revenue Recognition*” (SOP 97-2), issued by the
      American Institute of Certified Public Accountants (AICPA). Revenue from
      training, installation, consulting services and the associated hardware are
      recognized as the services are performed or product is delivered, provided
      there
      is vendor specific objective evidence (VSOE) of fair value which is the price
      charged when the services are sold separately. Revenues related to such sales
      generated during the year ended June 30, 2007 and 2006 were $49,000 and
      $121,000, respectively.  Revenues for the year ended June 30, 2005
      were immaterial.




§
            *Accounts
                Receivable and Allowance for Doubtful
                Accounts*




The
      Company maintains allowances for estimated losses resulting from the inability
      of its customers to make required payments. Judgments are used in determining
      the allowance for doubtful accounts and are based on a combination of factors.
      Such factors include historical collection experience, credit policy and
      specific customer collection issues. In circumstances where the Company is
      aware
      of a specific customer’s inability to meet its financial obligations to us
      (e.g., bankruptcy filings), we record a specific reserve for bad debts against
      amounts due to reduce the net recognized receivable to the amount we reasonably
      believe will be collected. We perform ongoing credit evaluations of our
      customers and continuously monitor collections and payments from our customers.
      While actual bad debts have historically been within our expectations and the
      provisions established, we cannot guarantee that we will continue to experience
      the same bad debt rates that we have in the past. A significant change in the
      liquidity or financial position of any of our customers could result in the
      uncollectibility of the related accounts receivable and could adversely impact
      our operating cash flows in that period.







31








§
            *Sales
                Returns and Allowances*




The
      Company records reductions to revenue for estimated customer returns and
      allowances. We record estimated allowances against revenues in the same period
      the revenue is recorded. These estimates are based upon historical analysis
      of
      our credit memo data and other known factors for pricing and disputes that
      arise
      in the normal course of business. To date, allowances have not been material.
      Actual returns may differ significantly from our estimates if factors such
      as
      economic conditions or competitive conditions differ from our
      expectations.




§
            *Inventories*




We
      value
      our inventories at lower of cost or market. Cost is determined by the first-in,
      first-out (FIFO) method, including material, labor and factory overhead. In
      assessing the ultimate realization of inventories, management judgment is
      required to determine the reserve for obsolete or excess inventory. Inventory
      on
      hand may exceed future demand either because the product is obsolete, or because
      the amount on hand is more than can be used to meet future need. We provide
      for
      the total value of inventories that we determine to be obsolete or excess based
      on criteria such as customer demand and changing technologies.




§
            *Warranties*




We
      provide for the estimated cost of product warranties at the time revenue is
      recognized. We record an estimate for warranty related costs at the time of
      sale
      based on our actual historical return rates and repair costs. While our warranty
      costs have historically been within our expectations and the provisions
      established, we cannot guarantee that we will continue to experience the same
      warranty return rates or repair costs that we have in the past. A significant
      increase in warranty return rates or costs to repair our products could have
      a
      material adverse impact on our operating results for the period or periods
      in
      which such returns or additional costs materialize.




§
            *Valuation
                of Certain Marketable Equity
                Securities*




The
      Company currently classifies its investment securities as available-for-sale
      securities. Pursuant to SFAS No. 115, “Accounting for Certain Investments in
      Debt and Equity Securities,” such securities are measured at fair market value
      in the financial statements with unrealized gains or losses recorded in
      accumulated other comprehensive income until the securities are sold or
      otherwise disposed of. However, in accordance with SFAS No. 115, a decline
      in
      fair market value below cost that is other than temporary is accounted for
      as a
      realized loss. To date, we have not experienced any realized
      losses.





·
            *Income
                Taxes*




Significant
      management judgment is required in determining our provision for income taxes,
      our deferred tax assets and liabilities and any valuation allowance recorded
      against deferred tax assets. We have recorded a full valuation allowance against
      our net deferred tax assets of $8,270,000 as of June 30, 2007, due to
      uncertainties related to our ability to utilize these assets. The valuation
      allowance is based on our estimates of taxable income and the period over which
      our deferred tax assets will be recoverable. In the event that actual results
      differ from these estimates or we adjust these estimates in future periods
      we
      may need to adjust our valuation allowance which could materially impact our
      financial position and results of operations.





§
            *Goodwill
                and Intangible Assets*




SFAS
      No.
      142, “Goodwill and Other Intangible Assets,” requires that goodwill and
      intangible assets with indefinite lives no longer be amortized but instead
      be
      measured for impairment at least annually or whenever events indicate that
      there
      may be an impairment. In order to determine if an impairment exists, management
      compares the reporting unit's carrying value to the reporting unit's fair value.
      Determining the reporting unit's fair value requires management to make
      estimates based on market conditions and operational performance. Absent an
      event that indicates a specific impairment may exist, management has selected
      August 31st as the date of performing the annual goodwill impairment test.
      Future events could cause management to conclude that impairment indicators
      exist and that goodwill associated with the Company’s acquired businesses is
      impaired. Any resulting impairment loss could have a material adverse impact
      on
      the Company’s financial condition and results of operations.






32






Intangible
      assets with finite lives consist of acquired customer base, technology and
      trademarks and are valued according to the future cash flows they are estimated
      to produce. These assigned values are amortized on a basis which matches the
      periods in which those cash flows are estimated to be produced or straight
      line
      over the estimated useful lives, if no other method provides a better result.
      The Company continually evaluates whether events or circumstances have occurred
      that indicate that the estimated remaining useful life of our intangible assets
      may warrant revision or that the carrying value of these assets may be impaired.
      To compute whether intangible assets with finite lives been impaired, the
      estimated undiscounted future cash flows for the estimated remaining useful
      life
      of the assets are compared to the carrying value. To the extent that the future
      cash flows are less than the carrying value, the assets are written down to
      the
      estimated fair value of the asset.





§
            *Equity
                Transactions*




The
      Company evaluates the proper classification of its equity transactions under
      SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristic
      of Both Liabilities and Equity.” SFAS No. 150 requires that for instruments that
      embody an unconditional obligation requiring the issuer to redeem it by
      transferring assets at a determinable date or that contain certain conditional
      obligations, typically classified as equity, be classified as a
      liability.





In
      many
      of our financing transactions, warrants have been issued. Additionally, we
      issue
      options and warrants to non-employees from time to time as payment for services.
      In all of these cases, we apply the principles of SFAS No. 123-R “Accounting for
      Stock-based Compensation” to value these awards, which inherently include a
      number of estimates and assumptions including stock price volatility factors.
      The Company records financing and certain offering costs associated with its
      capital raising efforts in its statements of operations. These include
      amortization of debt issue costs such as cash, warrants and other securities
      issued to finders and placement agents, and amortization of preferred stock
      discount created by in-the-money conversion features on convertible debt
      accounted for in accordance with Emerging Issues Task Force (“EITF”) Issue 98-5,
“Accounting for Convertible Securities with Beneficial Conversion Features or
      Contingently Adjustable Conversion Ratios,” and Issue 00-27, “Application of
      Issue 98-5 to Certain Convertible Instruments,” by other securities issued in
      connection with preferred stock as a result of allocating the proceeds amongst
      the securities in accordance with Accounting Principles Board (“APB”) Opinion
      No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase
      Warrants,” based on their relative fair values. We based our estimates and
      assumptions on the best information available at the time of valuation, however,
      changes in these estimates and assumptions could have a material effect on
      the
      valuation of the underlying instruments.





The
      Company determined its Series D Redeemable Convertible Preferred Stock contained
      certain derivative instruments and accounts for such instruments under SFAS
      No.
      133, “Accounting for Derivative Instruments and Hedging Activities.” Under SFAS
      No. 133, the Company bifurcated these derivative instruments from the Series
      D
      Redeemable Convertible Preferred Stock, recorded them as a liability, and
      includes the changes in the fair value of the instruments within other income
      (expense) in the accompanying consolidated statement of operations.




*Recent
      Accounting Pronouncements*




In
      June
      2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation (“FIN”) No. 48, "*Accounting for Uncertainty in Income
      Taxes*", which clarifies the accounting for uncertainty in income taxes
      recognized in an enterprise's financial statements in accordance with Statement
      of Financial Accounting Standards (“SFAS”) No. 109, "*Accounting for Income
      Taxes*." FIN No. 48 establishes a recognition threshold and measurement
      attribute for the financial statement recognition and measurement of a tax
      position taken or expected to be taken in a tax return. This interpretation
      also
      provides guidance on derecognition, classification, interest and penalties,
      accounting in interim periods, disclosure and transition. FIN No. 48 is
      effective for fiscal years beginning after December 15, 2006.  The
      adoption of FIN 48 is not expected to have a material impact on the Company’s
      consolidated financial statements.






33






In
      September 2006, the FASB issued SFAS No. 157, "*Fair Value
      Measurements*." This new standard provides guidance for using fair value to
      measure assets and liabilities. The FASB believes SFAS No. 157 also responds
      to
      investors' requests for expanded information about the extent to which companies
      measure assets and liabilities at fair value, the information used to measure
      fair value, and the effect of fair value measurements on earnings. SFAS No.
      157
      applies whenever other standards require (or permit) assets or liabilities
      to be
      measured at fair value but does not expand the use of fair value in any new
      circumstances. SFAS No. 157 is effective for fiscal years beginning after
      November 15, 2007. The Company is currently evaluating the provisions of this
      standard and is not certain of the potential impact at this time.




In
      December 2006, the FASB issued Staff Position No. EITF 00-19-2 ("FSP"). This
      FSP
      addresses an issuer's accounting for registration payment arrangements and
      specifies that the contingent obligation to make future payments or otherwise
      transfer consideration under a registration payment arrangement should be
      separately recognized and measured in accordance with FASB No. 5. The guidance
      in this FSP amends FASB Statements 133 and 150 and FASB Interpretation No.
      45 to
      include scope exceptions for registration payment arrangements. This FSP further
      clarifies that a financial instrument subject to a registration payment
      arrangement should be accounted for without regard to the contingent obligation
      to transfer consideration pursuant to the registration payment arrangement.
      This
      guidance is effective for financial statements issued for fiscal years beginning
      after December 15, 2006. The Company has adopted this FSP in the current fiscal
      year ending June 30, 2007. The Company's adoption of this FSP in the current
      fiscal year has not had a material effect on its financial position, operations
      or cash flow.




In
      February 2007, the FASB issued SFAS No. 159, “*The Fair Value Option for
      Financial Assets and Financial Liabilities”*, which provides companies with
      an option to report selected financial assets and liabilities at fair value.
      The
      objective of SFAS No. 159 is to reduce both complexity in accounting for
      financial instruments and the volatility in earnings caused by measuring related
      assets and liabilities differently. SFAS No. 159 establishes presentation and
      disclosure requirements designed to facilitate comparisons between companies
      that choose different measurement attributes for similar types of assets and
      liabilities and to more easily understand the effect of the company’s choice to
      use fair value on its earnings. SFAS No. 159 also requires entities to display
      the fair value of the selected assets and liabilities on the face of the balance
      sheet. SFAS No. 159 does not eliminate disclosure requirements of other
      accounting standards, including fair value measurement disclosures in SFAS
      No.
      157. This Statement is effective as of the beginning of an entity’s first fiscal
      year beginning after November 15, 2007. Early adoption is permitted as of the
      beginning of the previous fiscal year provided that the entity makes that choice
      in the first 120 days of that fiscal year and also elects to apply the
      provisions of Statement No. 157. Adoption of SFAS No. 159 is not expected to
      have a material impact on the Company’s results of operations or financial
      position.






**ITEM
      7A.                    QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**





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








34










**ITEM
      8.                   CONSOLIDATED
      FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**





Our
      consolidated financial statements and related report of independent registered
      public accounting firm are appended to the end of this Form 10-K for the fiscal
      year ended June 30, 2007 and contain the following:








Reports
      of Independent Registered Public Accounting Firms


Consolidated
      Balance Sheets as of June 30, 2007 and 2006


Consolidated
      Statements of Operations for the years ended June 30, 2007, 2006 and
      2005


Consolidated
      Statements of Changes in Stockholders’ Equity and Comprehensive Income (Loss)
      for the years ended June 30, 2007, 2006 and 2005


Consolidated
      Statements of Cash Flows for the years ended June 30, 2007, 2006 and
      2005


Notes
      to
      Consolidated Financial Statements

























35








Report
      of
      Independent Registered Public Accounting Firm





To
      the
      Board of Directors and Stockholders of


Implant
      Sciences Corporation:








We
      have
      audited the accompanying consolidated balance sheets of Implant Sciences
      Corporation and subsidiaries (the “Company”) as of June 30, 2007 and 2006 and
      the related consolidated statements of operations, stockholders’ equity and
      comprehensive loss, and cash flows for the years then ended. These
      financial statements are the responsibility of the Company’s management. Our
      responsibility is to express an opinion on these financial statements based
      on
      our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. The Company is not required to
      have, nor were we engaged to perform, an audit of its internal controls over
      financial reporting. Our audit included consideration of internal control over
      financial reporting as a basis for designing audit procedures that are
      appropriate in the circumstances, but not for the purpose of expressing an
      opinion on the effectiveness of the Company’s internal control over financial
      reporting. Accordingly, we express no such opinion. An audit also includes
      examining, on a test basis, evidence supporting the amounts and disclosures
      in
      the financial statements, assessing the accounting principles used and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of Implant Sciences Corporation
      and subsidiaries at June 30, 2007 and 2006 and the results of their operations
      and their cash flows for the years then ended, in conformity with accounting
      principles generally accepted in the United States of America.




The
      accompanying consolidated financial statements have been prepared assuming
      that
      the Company will continue as a going concern. As discussed in Note 1 to the
      consolidated financial statements, the Company has suffered recurring losses
      from operations which raises substantial doubt about its ability to
      continue as a going concern. Management's plans in regard to these matters
      are
      also described in Note 1. The consolidated financial statements do not include
      any adjustments that might result from the outcome of this
      uncertainty.




/s/
                UHY LLP







Boston,
      Massachusetts


October
      12, 2007




















36











Report
      of Independent Registered
      Public Accounting Firm




To
      the
      Board of Directors and Stockholders of


Implant
      Sciences Corporation:




We
      have
      audited the accompanying consolidated statements of operations, stockholders’
equity and comprehensive income (loss) and cash flows of Implant Sciences
      Corporation and subsidiaries (the “Company”) for the year ended June 30,
      2005.  These financial statements are the responsibility of the Company’s
      management. Our responsibility is to express an opinion on these financial
      statements based on our audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States).  Those standards require that
      we plan and perform the audit to obtain reasonable assurance about whether
      the
      financial statements are free of material misstatement.  The Company is not
      required to have, nor were we engaged to perform, an audit of its internal
      controls over financial reporting.  Our audit includes consideration of
      internal control over financial reporting as a basis for designing audit
      procedures that are appropriate in the circumstances, but not for the purpose
      of
      expressing an opinion on the effectiveness of the Company’s internal control
      over financial reporting. Accordingly, we express no such opinion. An audit
      also
      includes examining, on a test basis, evidence supporting the amounts and
      disclosures in the financial statements, assessing the accounting principles
      used and significant estimates made by management, as well as evaluating the
      overall financial statement presentation.  We believe that our audit
      provides a reasonable basis for our opinion.




In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the results of operations and cash flows of Implant
      Sciences Corporation and subsidiaries for the year ended June 30, 2005, in
      conformity with accounting principles generally accepted in the United States
      of
      America.




The
      accompanying consolidated financial statements have been prepared assuming
      that
      the Company will continue as a going concern. As discussed in Note 1 to the
      consolidated financial statements, the Company has suffered recurring losses
      from operations and has working capital and stockholder deficits as of June
      30,
      2005. These matters raise substantial doubt about its ability to continue as
      a
      going concern.  Management’s plans in regard to these matters are also
      described in Note 1. The consolidated financial statements do not include any
      adjustments that might result from the outcome of this uncertainty.




/s/
                  BDO Seidman, LLP





Boston,
      Massachusetts


October
      10, 2005, except for the effects of the discontinued operation presentation
      of
      the Accurel division as to which the date is October 12, 2007










37










**IMPLANT
                SCIENCES CORPORATION****CONSOLIDATED
                BALANCE SHEETS****June
                30,****ASSETS**
            
            **2007**
            
            
            **2006**Current
                assets:Cash
                and cash equivalents
            
            $
            9,621,000
            
            
            $
            2,074,000Accounts
                receivable, less allowance of $99,000 and $113,000,
                respectively
            
            
            1,891,000
            
            
            
            2,420,000Accounts
                receivable, unbilled
            
            
            162,000
            
            
            
            21,000Inventories
            
            
            1,166,000
            
            
            
            1,532,000Investments
                - available for sale securities
            
            
            158,000
            
            
            
            222,000Prepaid
                expenses and other current assets
            
            
            755,000
            
            
            
            435,000Current
                assets of discontinued operations
            
            
            -
            
            
            
            1,497,000Total
                current assets
            
            
            13,753,000
            
            
            
            8,201,000Property
                and equipment, net
            
            
            2,922,000
            
            
            
            5,845,000Amortizable
                intangible assets, net
            
            
            77,000
            
            
            
            404,000Investment
                in unconsolidated subsidiary
            
            
            -
            
            
            
            174,000Other
                non-current assets
            
            
            786,000
            
            
            
            146,000Goodwill
            
            
            2,062,000
            
            
            
            4,091,000Non-current
                assets of discontinued operations
            
            
            -
            
            
            
            11,938,000Total
                assets
            
            $
            19,600,000
            
            
            $
            30,799,000**LIABILITIES
                AND STOCKHOLDERS' EQUITY**Current
                liabilities:Current
                maturities of long-term debt and obligations under capital
                lease
            
            $
            708,000
            
            
            $
            22,000Line
                of credit
            
            
            -
            
            
            
            1,000,000Payable
                to Med-Tec
            
            
            143,000
            
            
            
            233,000Accrued
                expenses
            
            
            2,098,000
            
            
            
            1,647,000Accounts
                payable
            
            
            1,133,000
            
            
            
            1,438,000Current
                portion of long- term lease liability
            
            
            301,000
            
            
            
            -Deferred
                revenue
            
            
            281,000
            
            
            
            408,000Current
                liabilities of discontinued operations
            
            
            -
            
            
            
            1,194,000Total
                current liabilities
            
            
            4,664,000
            
            
            
            5,942,000Long-term
                liabilities:Long-term
                debt and obligations under capital lease, net of current
                maturities
            
            
            633,000
            
            
            
            58,000Long-term
                lease liability
            
            
            735,000
            
            
            
            -Derivatives
                related to preferred stock features
            
            
            133,000
            
            
            
            1,094,000Non-current
                liabilities of discontinued operations
            
            
            -
            
            
            
            1,209,000Total
                liabilities
            
            
            6,165,000
            
            
            
            8,303,000Commitments
                and contingencies (Note 11)Series
                D Cumulative Redeemable Convertible Preferred Stock; $10 stated
                value;
              500,000
                shares authorized, 393,939 and 409,091 shares outstanding as of June
                30,
                2007 and 2006, respectively [liquidation value $3,939,000  and
                $4,091,000 at June 30, 2007 and 2006, respectively]
            
            
            2,989,000
            
            
            
            2,568,000Stockholders'
                equityCommon
                stock, $0.10 par value; 50,000,000 shares authorized at June 30,
                2007
                and
              2006,
                respectively; 11,835,661 and 11,733,804 shares issued
                and  outstanding at
              June
                30, 2007 and 2006, respectively
            
            
            1,183,000
            
            
            
            1,173,000Additional
                paid-in capital
            
            
            57,358,000
            
            
            
            55,282,000Accumulated
                deficit
            
            
            (47,927,000
            )
            
            
            (36,288,000
            )Deferred
                compensation
            
            
            (30,000
            )
            
            
            (17,000
            )Accumulated
                other comprehensive income (loss)
            
            
            (65,000
            )
            
            
            14,000Treasury
                stock, 10,545 and 26,994 common shares, respectively, at
                cost
            
            
            (73,000
            )
            
            
            (236,000
            )Total
                stockholders' equity
            
            
            10,446,000
            
            
            
            19,928,000Total
                liabilities and stockholders' equity
            
            $
            19,600,000
            
            
            $
            30,799,000


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









38







**IMPLANT
                SCIENCES CORPORATION****CONSOLIDATED
                STATEMENTS OF OPERATIONS****Years
                Ended June 30,****2007**
            
            
            **2006**
            
            
            **2005**Revenues:Medical
            
            $
            3,976,000
            
            
            $
            4,464,000
            
            
            $
            4,146,000Semiconductor
            
            
            6,874,000
            
            
            
            6,739,000
            
            
            
            4,356,000Security
                products
            
            
            4,582,000
            
            
            
            6,871,000
            
            
            
            1,510,000Total
                revenues
            
            
            15,432,000
            
            
            
            18,074,000
            
            
            
            10,012,000Cost
                of revenues:Cost
                of medical revenues
            
            
            3,717,000
            
            
            
            3,869,000
            
            
            
            3,821,000Cost
                of semiconductor revenues
            
            
            6,406,000
            
            
            
            6,364,000
            
            
            
            4,797,000Cost
                of security product revenues
            
            
            3,332,000
            
            
            
            6,222,000
            
            
            
            1,919,000Total
                cost of revenues
            
            
            13,455,000
            
            
            
            16,455,000
            
            
            
            10,537,000Gross
                margin
            
            
            1,977,000
            
            
            
            1,619,000
            
            
            
            (525,000
            )Operating
                expenses:Research
                and development
            
            
            1,844,000
            
            
            
            1,313,000
            
            
            
            1,942,000Selling,
                general and administrative
            
            
            6,578,000
            
            
            
            7,300,000
            
            
            
            4,972,000Impairment
                of long lived assets
            
            
            3,829,000
            
            
            
            457,000
            
            
            
            -Gain
                on sale of asset
            
            
            (118,000
            )
            
            
            -
            
            
            
            -Total
                operating expenses
            
            
            12,133,000
            
            
            
            9,070,000
            
            
            
            6,914,000Loss
                from operations
            
            
            (10,156,000
            )
            
            
            (7,451,000
            )
            
            
            (7,439,000
            )Other
                income (expenses):Interest
                income
            
            
            122,000
            
            
            
            50,000
            
            
            
            48,000Interest
                expense
            
            
            (656,000
            )
            
            
            (168,000
            )
            
            
            (105,000
            )Loss
                on extinguishment of debt instrument
            
            
            -
            
            
            
            (1,294,000
            )
            
            
            -Loss
                on disposal of assets
            
            
            (37,000
            )
            
            
            (4,000
            )
            
            
            (2,000
            )Change
                in fair value of embedded derivatives related to preferred stock
                features
            
            
            961,000
            
            
            
            1,121,000
            
            
            
            -Equity
                losses in unconsolidated subsidiaries
            
            
            (158,000
            )
            
            
            (359,000
            )
            
            
            (75,000
            )Total
                other income (expense), net
            
            
            232,000
            
            
            
            (654,000
            )
            
            
            (134,000
            )Loss
                from continuing operations
            
            
            (9,924,000
            )
            
            
            (8,105,000
            )
            
            
            (7,573,000
            )Preferred
                distribution, dividends and accretion
            
            
            (951,000
            )
            
            
            (1,089,000
            )
            
            
            (1,183,000
            )Loss
                from continuing operations applicable to common
                shareholders
            
            
            (10,875,000
            )
            
            
            (9,194,000
            )
            
            
            (8,756,000
            )Income
                from discontinued operations
            
            
            482,000
            
            
            
            1,021,000
            
            
            
            168,000Loss
                on sale of discontinued operation, net of tax of
                $197,000
            
            
            (1,246,000
            )
            
            
            -
            
            
            
            -Income
                (loss) from discontinued operations
            
            
            (764,000
            )
            
            
            1,021,000
            
            
            
            168,000Net
                loss applicable to common shareholders
            
            $
            (11,639,000
            )
            
            $
            (8,173,000
            )
            
            $
            (8,588,000
            )Net
                loss
            
            $
            (10,688,000
            )
            
            $
            (7,084,000
            )
            
            $
            (7,405,000
            )Loss
                per share from continuing operations, basic and diluted
            
            $
            (0.84
            )
            
            $
            (0.72
            )
            
            $
            (0.80
            )Loss
                per share from continuing operations applicable to common shareholders,
                basic and diluted
            
            $
            (0.92
            )
            
            $
            (0.81
            )
            
            $
            (0.93
            )Income
                (loss) per share from discontinued operations, basic and
                diluted
            
            $
            (0.07
            )
            
            $
            0.09
            
            
            $
            0.02Net
                loss per share applicable to common shareholders, basic and
                diluted
            
            $
            (0.99
            )
            
            $
            (0.72
            )
            
            $
            (0.91
            )Net
                loss per share
            
            $
            (0.91)
            
            
            $
            (0.63)
            
            
            $
            (0.77)Weighted
                average common shares outstanding used in computing basic and diluted
                income (loss) per share
            
            
            11,794,599
            
            
            
            11,325,842
            
            
            
            9,412,548




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










39




**IMPLANT
                    SCIENCES
                    CORPORATION****STATEMENTS
                    OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
                    (LOSS)****FOR
                    THE YEARS ENDED JUNE 30, 2005 , 2006 AND 2007**Common
                    Stock
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                Treasury
                    StockNumber
                    of shares
                
                
                $.10
                    par value
                
                
                Additional Paid-in
                    Capital
                
                
                Accumulated
                    Deficit
                
                
                Deferred
                    Compensation
                
                
                Accumulated
                    Other Comprehensive Income (Loss)
                
                
                Shares
                
                
                Cost
                
                
                Total
                    Stockholders' Equity
                
                
                Comprehensive
                    LossBalance
                    at June 30, 2004
                
                
                8,370,338
                
                
                $
                837,000
                
                
                $
                31,360,000
                
                
                $
                (19,527,000
                )
                
                $
                (449,000
                )
                
                $
                313,000
                
                
                
                3,103
                
                
                $
                (34,000
                )
                
                $
                12,500,000
                
                
                
                -Issuance
                    of common stock pursuant to exercise of stock options
                
                
                153,160
                
                
                
                15,000
                
                
                
                856,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                871,000
                
                
                
                -Issuance
                    of common stock pursuant to exercise of warrants
                
                
                42,810
                
                
                
                4,000
                
                
                
                137,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                141,000
                
                
                
                -Issuance
                    of common stock pursuant to employee stock purchase plan
                
                
                3,075
                
                
                
                -
                
                
                
                25,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                25,000
                
                
                
                -Issuance
                    of common stock pursuant to private financing agreement, net
                    of issuance
                    costs
                
                
                1,080,780
                
                
                
                108,000
                
                
                
                7,181,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                7,289,000
                
                
                
                -Conversion
                    of 5% Series C Cumulative Convertible Preferred Stock and related
                    accrued
                    dividends into common stock
                
                
                208,289
                
                
                
                21,000
                
                
                
                1,417,000
                
                
                
                (55,000
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                1,383,000
                
                
                
                -Accretion
                    and dividends on 5% Series C Cumulative Convertible Preferred
                    Stock
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (649,000
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (649,000
                )
                
                
                -Investment
                    in unconsolidated subsidiaries (Note 8)
                
                
                76,687
                
                
                
                8,000
                
                
                
                742,000
                
                
                
                -
                
                
                
                -
                
                
                
                (78,000
                )
                
                
                13,346
                
                
                
                (129,000
                )
                
                
                543,000
                
                
                
                (78,000
                )Issuance
                    of common stock pursuant to investment in Core Systems
                
                
                311,437
                
                
                
                31,000
                
                
                
                3,219,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                3,250,000
                
                
                
                -Issuance
                    of common stock in exchange for the retirement of debt in connection
                    with
                    the acquisition of Core Systems
                
                
                48,875
                
                
                
                5,000
                
                
                
                505,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                510,000
                
                
                
                -Issuance
                    of common stock warrants in connection with the acquisition of
                    Core
                    Systems
                
                
                -
                
                
                
                -
                
                
                
                1,122,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                1,122,000
                
                
                
                -Issuance
                    of common stock pursuant to investment in Accurel Systems
                    International
                
                
                418,194
                
                
                
                42,000
                
                
                
                3,478,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                3,520,000
                
                
                
                -Fair
                    value associated with warrants and nonqualified stock options
                    issued to
                    nonemployees (Note 14)
                
                
                -
                
                
                
                -
                
                
                
                228,000
                
                
                
                -
                
                
                
                (129,000
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                99,000
                
                
                
                -Value
                    ascribed to stock options issued to employees below fair market
                    value
                
                
                -
                
                
                
                -
                
                
                
                144,000
                
                
                
                -
                
                
                
                (144,000
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Purchase
                    of treasury stock
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                6,000
                
                
                
                (54,000
                )
                
                
                (54,000
                )
                
                
                -Amortization
                    of deferred compensation
                
                
                -
                
                
                
                -
                
                
                
                (94,000
                )
                
                
                -
                
                
                
                373,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                279,000
                
                
                
                -Issuance
                    of common stock for assets acquired from Rosses Medical
                
                
                43,197
                
                
                
                4,000
                
                
                
                196,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                200,000
                
                
                
                -Unrealized
                    gain on available for sale securities
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (240,000
                )
                
                
                -
                
                
                
                -
                
                
                
                (240,000
                )
                
                
                (240,000
                )Value
                    of underwriter IPO unit warrant extension (Note 14)
                
                
                -
                
                
                
                -
                
                
                
                479,000
                
                
                
                (479,000
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Net
                    loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (7,405,000
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (7,405,000
                )
                
                
                (7,405,000
                )Balance
                    at June 30, 2005
                
                
                10,756,842
                
                
                $
                1,075,000
                
                
                $
                50,995,000
                
                
                $
                (28,115,000
                )
                
                $
                (349,000
                )
                
                $
                (5,000
                )
                
                
                22,449
                
                
                $
                (217,000
                )
                
                $
                23,384,000
                
                
                $
                (7,723,000
                )






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





40




**IMPLANT
                  SCIENCES CORPORATION****STATEMENTS
                  OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
                  (LOSS)****FOR
                  THE YEARS ENDED JUNE 30, 2005, 2006 AND 2007**Common
                  Stock
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              Treasury
                  StockNumber
                  of shares
              
              
              $.10
                  par value
              
              
              Additional Paid-in
                  Capital
              
              
              Accumulated
                  Deficit
              
              
              Deferred
                  Compensation
              
              
              Accumulated
                  Other Comprehensive Income (Loss)
              
              
              Shares
              
              
              Cost
              
              
              Total
                  Stockholders’ Equity
              
              
              Comprehensive
                  LossBalance
                  at June 30, 2005
              
              
              10,756,842
              
              
              $
              1,075,000
              
              
              $
              50,995,000
              
              
              $
              (28,115,000
              )
              
              $
              (349,000
              )
              
              $
              (5,000
              )
              
              
              22,449
              
              
              $
              (217,000
              )
              
              $
              23,384,000
              
              
              
              -Employee
                  Stock Purchase Plan
              
              
              41,204
              
              
              
              4,000
              
              
              
              100,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              104,000
              
              
              
              -Stock
                  issued for option exercises
              
              
              41,700
              
              
              
              4,000
              
              
              
              66,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              4,545
              
              
              
              (19,000
              )
              
              
              51,000
              
              
              
              -Stock
                  issued with warrant exercises
              
              
              16,185
              
              
              
              2,000
              
              
              
              69,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              71,000
              
              
              
              -Warrants
                  issued to consultants for services
              
              
              -
              
              
              
              -
              
              
              
              119,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              119,000
              
              
              
              -S-3
                  expenses
              
              
              -
              
              
              
              -
              
              
              
              (9,000
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (9,000
              )
              
              
              -Shares
                  issued in conjunction with Core Systems
              
              
              112,495
              
              
              
              11,000
              
              
              
              (11,000
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Shares
                  issued in conjunction with Accurel Systems
              
              
              504,145
              
              
              
              51,000
              
              
              
              (51,000
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Series
                  D expenses
              
              
              -
              
              
              
              -
              
              
              
              (71,000
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (71,000
              )
              
              
              -Warrants
                  issued in connection with Series D
              
              
              -
              
              
              
              -
              
              
              
              672,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              672,000
              
              
              
              -Amortization
                  of deferred compensation
              
              
              -
              
              
              
              -
              
              
              
              (305,000
              )
              
              
              -
              
              
              
              332,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              27,000
              
              
              
              -Share-based
                  compensation
              
              
              -
              
              
              
              -
              
              
              
              2,348,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              2,348,000
              
              
              
              -Shares
                  issued in conjunction with conversion of Series D
              
              
              261,233
              
              
              
              26,000
              
              
              
              883,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              909,000
              
              
              
              -Series
                  D conversion expense
              
              
              -
              
              
              
              -
              
              
              
              477,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              477,000
              
              
              
              -Series
                  D accretion and dividends
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (1,089,000
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (1,089,000
              )
              
              
              -Unrealized
                  gain on available for sale securities
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              19,000
              
              
              
              -
              
              
              
              -
              
              
              
              19,000
              
              
              
              19,000Net
                  loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (7,084,000
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (7,084,000
              )
              
              
              (7,084,000
              )Balance
                  at June 30, 2006
              
              
              11,733,804
              
              
              $
              1,173,000
              
              
              $
              55,282,000
              
              
              $
              (36,288,000
              )
              
              $
              (17,000
              )
              
              $
              14,000
              
              
              
              26,994
              
              
              $
              (236,000
              )
              
              $
              19,928,000
              
              
              $
              (7,065,000
              )


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







41





**IMPLANT
                  SCIENCES CORPORATION****STATEMENTS
                  OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
                  (LOSS)****FOR
                  THE YEARS ENDED JUNE 30, 2005, 2006 AND 2007**Common
                  Stock
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              Treasury
                  StockNumber
                  of shares
              
              
              $.10
                  par value
              
              
              Additional Paid-in
                  Capital
              
              
              Accumulated
                  Deficit
              
              
              Deferred
                  Compensation
              
              
              Accumulated
                  Other Comprehensive Income (Loss)
              
              
              Shares
              
              
              Cost
              
              
              Total
                  Stockholders' Equity
              
              
              Comprehensive
                  LossBalance
                  at June 30, 2006
              
              
              11,733,804
              
              
              $
              1,173,000
              
              
              $
              55,282,000
              
              
              $
              (36,288,000
              )
              
              $
              (17,000
              )
              
              $
              14,000
              
              
              
              26,994
              
              
              $
              (236,000
              )
              
              $
              19,928,000
              
              
              
              -Employee
                  Stock Purchase Plan
              
              
              67,492
              
              
              
              7,000
              
              
              
              149,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              156,000
              
              
              
              -Stock
                  issued for option exercises
              
              
              34,365
              
              
              
              3,000
              
              
              
              47,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              50,000
              
              
              
              -Warrants
                  issued to consultants for services
              
              
              -
              
              
              
              -
              
              
              
              136,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              136,000
              
              
              
              -Warrants
                  issued in connection with Accurel sale
              
              
              -
              
              
              
              -
              
              
              
              389,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              389,000
              
              
              
              -Warrants
                  issued in connection with Laurus Master Fund Short term
                  note
              
              
              -
              
              
              
              -
              
              
              
              450,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              450,000
              
              
              
              -Warrants
                  issued in connection with Bridge Bank loan
              
              
              -
              
              
              
              -
              
              
              
              28,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              28,000
              
              
              
              -Amortization
                  of deferred compensation
              
              
              -
              
              
              
              -
              
              
              
              18,000
              
              
              
              -
              
              
              
              (13,000
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              5,000
              
              
              
              -Share-based
                  compensation
              
              
              -
              
              
              
              -
              
              
              
              1,022,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,022,000
              
              
              
              -Series
                  D accretion and dividends
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (951,000
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (951,000
              )
              
              
              -Effect
                  of CorNova’s IMX stock transaction
              
              
              -
              
              
              
              -
              
              
              
              (163,000
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (16,449
              )
              
              
              163,000
              
              
              
              -
              
              
              
              -Unrealized
                  gain on available for sale securities
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (79,000
              )
              
              
              -
              
              
              
              -
              
              
              
              (79,000
              )
              
              
              (79,000
              )Net
                  loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (10,688,000
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (10,688,000
              )
              
              
              (10,688,000
              )Balance
                  at June 30, 2007
              
              
              11,835,661
              
              
              $
              1,183,000
              
              
              $
              57,358,000
              
              
              $
              (47,927,000
              )
              
              $
              (30,000
              )
              
              $
              (65,000
              )
              
              
              10,545
              
              
              $
              (73,000
              )
              
              $
              10,446,000
              
              
              $
              (10,767,000
              )







42





**IMPLANT
                  SCIENCES CORPORATION****CONSOLIDATED
                  STATEMENTS OF CASH FLOWS****Years
                  Ended June 30,****Cash
                  flows from operating activities:**
              
              **2007**
              
              
              **2006**
              
              
              **2005**Loss
                  from continuing operations
              
              $
              (9,924,000
              )
              
              $
              (8,105,000
              )
              
              $
              (7,573,000
              )Income
                  (loss) from discontinued operations
              
              
              (764,000
              )
              
              
              1,021,000
              
              
              
              168,000Net
                  loss
              
              
              (10,688,000
              )
              
              
              (7,084,000
              )
              
              
              (7,405,000
              )Adjustments
                  to reconcile net loss to net cash provided by (used in) operating
                  activities:Depreciation
                  and amortization
              
              
              1,467,000
              
              
              
              1,411,000
              
              
              
              1,332,000Amortization
                  of intangible assets
              
              
              167,000
              
              
              
              375,000
              
              
              
              481,000Share-based
                  compensation expense
              
              
              956,000
              
              
              
              2,234,000
              
              
              
              378,000Equity
                  loss in unconsolidated subsidiaries
              
              
              158,000
              
              
              
              359,000
              
              
              
              75,000Loss
                  on equipment write down
              
              
              37,000
              
              
              
              43,000
              
              
              
              357,000Change
                  in fair value of embedded derivatives
              
              
              (961,000
              )
              
              
              (1,121,000
              )
              
              
              -Loss
                  on extinguishment of debt instrument
              
              
              -
              
              
              
              1,294,000
              
              
              
              -Loss
                  on lease
              
              
              487,000
              
              
              
              
              
              
              
              -Warrants
                  issued to non-employees
              
              
              136,000
              
              
              
              -
              
              
              
              -Warrant
                  accretion on Bridge Bank loan
              
              
              6,000
              
              
              
              
              
              
              
              -Non-cash
                  interest expense
              
              
              450,000
              
              
              
              
              
              
              
              -Impairment
                  of long lived assets
              
              
              3,829,000
              
              
              
              457,000
              
              
              
              -Gain
                  on asset sale
              
              
              (118,000
              )
              
              
              -
              
              
              
              -Changes
                  in operating assets and liabilities, net of effect of
                  acquisitions:Accounts
                  receivable
              
              
              388,000
              
              
              
              46,000
              
              
              
              174,000Inventories
              
              
              282,000
              
              
              
              (328,000
              )
              
              
              (549,000
              )Prepaid
                  expenses and other current assets
              
              
              40,000
              
              
              
              (281,000
              )
              
              
              34,000Accounts
                  payable
              
              
              (305,000
              )
              
              
              165,000
              
              
              
              21,000Accrued
                  expenses
              
              
              451,000
              
              
              
              (618,000
              )
              
              
              434,000Deferred
                  revenue
              
              
              (111,000
              )
              
              
              (329,000
              )
              
              
              714,000Net
                  cash used in continuing operations
              
              
              (3,329,000
              )
              
              
              (3,377,000
              )
              
              
              (3,954,000
              )Net
                  cash provided by discontinued operations
              
              
              845,000
              
              
              
              1,048,000
              
              
              
              625,000Net
                  cash used in operating activities
              
              
              (2,484,000
              )
              
              
              (2,329,000
              )
              
              
              (3,329,000
              )**Cash
                  flows from investing activities:**Purchase
                  of property and equipment
              
              
              (333,000
              )
              
              
              (497,000
              )
              
              
              (679,000
              )Investment
                  in available for sale securities
              
              
              1,000
              
              
              
              (1,000
              )
              
              
              (25,000
              )Acquisition
                  of Core Systems, net of cash received
              
              
              -
              
              
              
              -
              
              
              
              (2,404,000
              )Acquisition
                  of Accurel Systems International, net of cash received
              
              
              -
              
              
              
              -
              
              
              
              (6,425,000
              )Proceeds
                  from sale of Accurel, net of transaction costs and escrow
              
              
              9,521,000
              
              
              
              -
              
              
              
              -Proceeds
                  from sale of brachytherapy assets, net of transaction
                  costs
              
              
              305,000
              
              
              
              -
              
              
              
              -Payments
                on lease liability
              
              
              (48,000
              )
              
              
              -
              
              
              
              -Increase
                  in other non-current assets
              
              
              -
              
              
              
              (37,000
              )
              
              
              (75,000
              )Net
                  cash provided by (used in) continuing operations
              
              
              9,446,000
              
              
              
              (535,000
              )
              
              
              (9,608,000
              )Net
                  cash provided by (used in) discontinued operations
              
              
              (121,000
              )
              
              
              (117,000
              )
              
              
              1,391,000Net
                  cash provided by (used in) investing activities
              
              
              9,325,000
              
              
              
              (652,000
              )
              
              
              (8,217,000
              )





43








**Cash
                flows from financing activities:**Proceeds
                from issuance of common stock including the
              exercise
                of options and the Employee Stock Purchase Plan
            
            
            206,000
            
            
            
            49,000
            
            
            
            896,000Proceeds
                from warrant exercise
            
            
            -
            
            
            
            70,000
            
            
            
            141,000Proceeds
                from term note, net of issuance costs
            
            
            -
            
            
            
            2,833,000
            
            
            
            -Proceeds
                from issuance of Series D Cumulative Redeemable Convertible
              Preferred
                Stock, net of issuance costs
            
            
            -
            
            
            
            1,894,000
            
            
            
            -Dividends
                on Series D Cumulative Redeemable Convertible Preferred
                Stock
            
            
            (379,000
            )
            
            
            (279,000
            )
            
            
            -Payments
                on Series D Cumulative Redeemable Convertible Preferred
                Stock
            
            
            (151,000
            )
            
            
            -
            
            
            
            -Proceeds
                from term note with Laurus
            
            
            1,500,000
            
            
            
            -
            
            
            
            -Payments
                on term note with Laurus
            
            
            (1,500,000
            )
            
            
            -
            
            
            
            -Proceeds
                from term note with Bridge Bank
            
            
            1,600,000
            
            
            
            -
            
            
            
            -Principal
                payments of long-term debt and capital lease obligations
            
            
            (414,000
            )
            
            
            (1,684,000
            )
            
            
            (871,000
            )Line
                of credit
            
            
            (1,000,000
            )
            
            
            1,000,000
            
            
            
            -Acquisition
                of treasury shares
            
            
            -
            
            
            
            -
            
            
            
            (54,000
            )Proceeds
                from issuance of common stock in connection with
              private
                placement, net of issuance costs
            
            
            -
            
            
            
            -
            
            
            
            7,289,000Net
                cash provided by (used in) continuing operations
            
            
            (138,000
            )
            
            
            3,883,000
            
            
            
            7,401,000Net
                cash provided by (used in) discontinued operations
            
            
            844,000
            
            
            
            (377,000
            )
            
            
            (1,212,000
            )Net
                cash flows provided by financing activities
            
            
            706,000
            
            
            
            3,506,000
            
            
            
            6,189,000Net
                change in cash and cash equivalents
            
            
            7,547,000
            
            
            
            525,000
            
            
            
            (5,357,000
            )Cash
                and cash equivalents at beginning of year
            
            
            2,074,000
            
            
            
            1,549,000
            
            
            
            6,906,000Cash
                and cash equivalents at end of year
            
            $
            9,621,000
            
            
            $
            2,074,000
            
            
            $
            1,549,000







**Years
                ended June 30,****2007**
            
            
            **2006**
            
            
            **2005****Supplemental
                Disclosure of Cash Flow Information:**Interest
                paid in cash
            
            $
            234,000
            
            
            $
            -
            
            
            $
            30,000**Non
                cash Investing and Financing Activity:**Value
                of IPO warrant extension
            
            $
            -
            
            
            $
            -
            
            
            $
            479,000Capital
                equipment acquired under capital lease
            
            $
            7,000
            
            
            $
            223,000
            
            
            $
            -Conversion
                of Series C Cumulative
                Convertible Preferred stockand accrued
                dividends into common
                stock
            
            $
            -
            
            
            $
            -
            
            
            $
            1,438,000Conversion
                of Series D Cumulative
                Convertible Preferred stockinto common
                stock
            
            $
            -
            
            
            $
            909,000
            
            
            $
            -Accretion
                of 5% Series C
                Cumulative Convertible Preferred Stockdividends,
                beneficial conversion
                feature and warrants
            
            $
            -
            
            
            $
            -
            
            
            $
            704,000Accretion
                of Series D Cumulative
                Redeemable Convertible Preferred Stockdividends,
                derivatives and
                warrants
            
            $
            572,000
            
            
            $
            628,000
            
            
            $
            -Value
                of software technology
                acquired in exchange for cash andshares of
                common
                stock
            
            $
            -
            
            
            $
            -
            
            
            $
            300,000Repayment
                of term note with Series D Cumulative Redeemable ConvertiblePreferred
                Stock
            
            $
            -
            
            
            $
            3,000,000
            
            
            $
            -Modification
                of embedded derivative related to Series D conversion
                feature
            
            $
            -
            
            
            $
            817,000
            
            
            $
            -Conversion
                of line of credit into term note
            
            $
            1,672,000
            
            
            $
            -
            
            
            $
            -Warrants
                issued to Laurus
            
            $
            450,000
            
            
            $
            -
            
            
            $
            -Warrants
                issued to Bridge Bank
            
            $
            28,000
            
            
            $
            -
            
            
            $
            -









44





**Supplemental
      Disclosure of Cash Flow Information**





**On
                October 15, 2004, the Company acquired Core Systems Incorporated
                -****Fair
                value of
                assets:**Accounts
                receivable
            
            $
            518,000Inventory
            
            
            174,000Property,
                plant and equipment
            
            
            3,422,000Intangible
                assets
            
            
            335,000Goodwill
            
            
            4,647,000Other
                assets
            
            
            74,000**Liabilities
                assumed:**Accounts
                payable and accrued expenses
            
            
            (1,063,000
            )Debt
                and capital leases
            
            
            (621,000
            )**Purchase
                price:**Cash
                paid for purchase of Core Systems, net of cash acquired
            
            
            (2,604,000
            )Fair
                value of warrants issued
            
            
            (1,122,000
            )Fair
                value of common stock issued
            
            $
            3,760,000










**On
                March 9, 2005, the
                Company acquired Accurel Systems International Corporation
                -****Fair
                value of
                assets:**Accounts
                receivable
            
            $
            1,073,000Property,
                plant and equipment
            
            
            3,957,000Assets
                held for sale
            
            
            1,400,000Intangible
                assets
            
            
            1,670,000Goodwill
            
            
            7,566,000Other
                assets
            
            
            183,000**Liabilities
                assumed:**Accounts
                payable and accrued expenses
            
            
            (557,000
            )Long-term
                lease liability
            
            
            (829,000
            )Debt
                and capital leases
            
            
            (2,440,000
            )**Purchase
                price:**Debt
                issued to selling shareholders
            
            
            (1,650,000
            )Cash
                paid for purchase of Accurel, net of cash acquired
            
            
            (6,853,000
            )Fair
                value of common stock issued
            
            $
            3,520,000







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








45





1.
            **Description
                of Business**




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





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





In
      connection with the Transaction, we entered into an escrow agreement (the
“Escrow Agreement”) with Evans, Accurel, and Zions First National Bank. 
Pursuant to the Escrow Agreement, Evans deposited $1,000,000 (the “Escrow
      Amount”) of the total purchase price for the assets into an escrow
      account.  Any valid claims for indemnification made by Evans pursuant to
      section 6.3 of the Purchase Agreement shall be drawn from this
      sum.  The Escrow Agreement provides, subject to any claims of
      indemnifications, for a release of $500,000 on approximately each of March
      31,
      2008 and March 31, 2009.





Also
      in
      connection with the Transaction, we entered into a Non-competition and
      Nondisclosure Agreement (the “NCD”) with Evans whereby we agreed not to engage
      in any business that directly competes with the business of
      Accurel.  In addition, the NCD prohibits us from disclosing any
      confidential information concerning the business of Accurel.  The NCD
      will remain in effect for five years from the date of its execution. The
      Company markets and sells its existing trace explosives detector products while
      continuing to make significant investments in developing the next generation
      of
      these products.





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





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








*Risks
      and Uncertainties*




While
      the Company strives to bring new
      products to market, it is subject to a number of risks similar to other
      technology-based companies, including risks related to: (a) its dependence
      on
      key individuals and collaborative research partners; (b) competition from
      substitute products and larger companies; (c) its ability to develop and market
      commercially usable products and obtain regulatory approval for its products
      under development; and (d) its ability to obtain the substantial additional
      financing necessary to adequately fund the development, commercialization and
      marketing of its products. For the year ended June 30, 2007, the Company
      reported a net loss applicable to common shareholders of $11,639,000 and used
      $2,484,000 in cash from operations. As of June 30, 2007, the Company had an
      accumulated deficit of approximately $47,927,000 and working capital of
      $9,089,000. The Company has a term loan with a bank, which matures in August
      2009 and has an unpaid balance of approximately $1,299,000. Management
      continually evaluates plans to reduce its operating expenses and increase its
      cash flow from operations. Failure of the Company to achieve its projections
      may
      require the Company to seek additional financing.






46





On
      January 3, 2007, the Company
      executed an agreement with Silicon Valley based Bridge Bank, N.A. which
      increased the Company’s revolving credit facility from $1.5 million to $5.0
      million (see Note 16).  Based on the current sales, expense and cash
      flow projections, and the proceeds from this facility and the sale of Accurel,
      the Company believes that the current level of cash and cash-equivalents on
      hand, and the net proceeds from current government contracts will be sufficient
      to fund operations for the next twelve months.  However, because there
      can be no assurances that sales will materialize as forecasted, management
      will
      continue to closely monitor and attempt to control costs at the Company and
      will
      continue to actively seek the needed capital through government grants and
      awards, strategic alliances, private financing sources, and through its lending
      institutions.





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





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





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





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





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








**2.**
            **Summary
                of Significant
                Accounting Policies**





*Principles
      of Consolidation*





The
      accompanying consolidated financial
      statements include the accounts of the Company and its wholly owned
      subsidiaries. All intercompany balances have been eliminated in
      consolidation*.*







47





*Use
      of Estimates*





The
      preparation of these financial
      statements in conformity with accounting principles generally accepted in the
      United States of America, requires management to make estimates and assumptions
      that affect the reported amounts of assets and liabilities and disclosure of
      contingent assets and liabilities at the date of the financial statements and
      the reported amounts of revenues and expenses during the reporting periods.
      Some
      of the more significant estimates include allowance for doubtful accounts,
      allowance for sales returns, inventory valuation, warranty reserves, accounting
      for embedded derivatives, and impairment of goodwill, intangibles and long-lived
      assets. Management's estimates are based on the facts and circumstances
      available at the time estimates are made, past historical experience, risk
      of
      loss, general economic conditions and trends and management's assessments of
      the
      probable future outcome of these matters. Consequently, actual results could
      differ from such estimates.





Certain
      amounts in 2005 and 2006 were reclassified to provide comparison with 2007
      classifications.





*Cash,
      Cash Equivalents, and Investments*





The
      Company considers any securities
      with original maturities of 90 days or less at the time of investment to be cash
      equivalents.





The
      Company accounts for investments in
      accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115,
“Accounting for Certain Investments in Debt and Equity Securities.” Under SFAS
      No. 115, securities purchased in order to be held for indefinite periods of
      time
      and not intended at the time of purchase to be held until maturity are
      classified as available-for-sale securities. At June 30, 2007 and June 30,
      2006,
      these securities consisted of common stock in CardioTech International, Inc.
      (“CardioTech”), a related party. This common stock is recorded at fair market
      value with any unrealized gains and losses reported as a separate component
      of
      equity in other accumulated comprehensive income (loss).





*Comprehensive
      Loss*





The
      Company has accumulated other
      comprehensive losses resulting from the unrealized losses on an investment
      in
      marketable securities of CardioTech and the recognition of the unrealized loss
      of the Company’s share of CardioTech stock owned by CorNova, Inc. (“CorNova”),
      which is recorded as a separate component of equity in other accumulated
      comprehensive loss.





*Financial
      Instruments*





The
      estimated fair values of the
      Company’s financial instruments, which at June 30, 2007 and 2006 include cash
      equivalents, investments in available for sale securities, accounts receivable,
      accounts payable and long-term debt, approximates their carrying values due
      to
      their short-term nature or market variable rates of interest.





*Inventories*





Inventories
      consist of raw materials,
      work-in-process and finished goods. Work-in-process and finished goods includes
      labor and overhead, and are stated at the lower of cost (first in, first out)
      or
      market.





*Property
      and Equipment*




Property,
      equipment and leasehold
      improvements are stated at cost. Equipment is depreciated using the
      straight-line method over the estimated useful lives of the assets, ranging
      from
      three to seven years. Equipment purchased under capital leases and leasehold
      improvements are amortized based upon the lesser of the term of the lease or
      the
      useful life of the asset and such expense is included in depreciation expense.
      Expenditures for repairs and maintenance are charged to expense as
      incurred.




Description
            Estimated
                LivesMachinery
                and equipment
            5
                -
                7 yearsComputers
                and software
            3
                -
                5 yearsLeasehold
                improvements and equipment
              under
                capital leases
            Lesser
                of the remaining life of the lease
              or
                the useful lifeFurniture
                and fixtures
            5
                -
                7 yearsMotor
                vehicles
            7
                years






48






*Warranty
      Costs*




The
      Company accrues warranty costs in
      the period the related revenue is recognized. The following table details the
      changes in the Company’s warranty reserve:





**Year
                ended June 30,****2007**
            
            
            **2006**
            
            
            **2005**Beginning
                balance
            
            $
            66,000
            
            
            $
            66,000
            
            
            $
            2,000Accrued
                warranty expense
            
            
            25,000
            
            
            
            133,000
            
            
            
            64,000Charges
                against the reserve
            
            
            (34,000
            )
            
            
            (133,000
            )
            
            
            -Ending
                balance
            
            $
            57,000
            
            
            $
            66,000
            
            
            $
            66,000


*Income
      Taxes*




The
      liability method is used to account
      for income taxes. Deferred tax assets and liabilities are determined based
      on
      differences between the financial reporting and income tax bases of assets
      and
      liabilities as well as net operating loss and tax credit carry forwards and
      are
      measured using the enacted tax rates and laws that will be in effect when the
      differences reverse. Deferred tax assets may be reduced by a valuation allowance
      to reflect the uncertainty associated with their ultimate
      realization.




*Patent
      Costs*




As
      of June 30, 2007, there were 20
      active patents issued. The Company expenses patent costs as
      incurred.




*Goodwill,
      Intangibles and Long-lived Assets*





In
      accordance with SFAS No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company
      reviews the carrying values of its long-lived assets for possible impairment
      whenever events or changes in circumstances indicate that the carrying amounts
      of the assets may not be recoverable.





At
      June 30, 2007, the Company had
      goodwill of $2,062,000.  SFAS No. 142, “Goodwill and Other Intangible
      Assets,” requires that goodwill and intangible assets with indefinite lives no
      longer be amortized but instead be measured for impairment at least annually
      or
      whenever events indicate that there may be an impairment. In order to determine
      if impairment exists, management continually compares the reporting unit's
      carrying value to the reporting unit's fair value. The Company has three
      reporting units, medical, explosives detection, and semiconductor wafer
      processing services. All of the Company’s goodwill was allocated to the
      semiconductor wafer processing reporting units. Determining the reporting unit's
      fair value requires management to make estimates based on market conditions
      and
      operational performance. Absent an event that indicates a specific impairment
      may exist, management has selected August 31st as the date of performing the
      annual goodwill impairment test.





At
      June 30, 2007 the Company determined
      that long-lived assets of its semiconductor reporting unit including its
      goodwill and intangibles were impaired. As a result of this impairment the
      Company took an impairment charge of $3,829,000 in the year ended June 30,
      2007.





Intangible
      assets with finite lives
      consist of acquired customer base, technology and trademarks and are valued
      according to the future cash flows they are estimated to produce. These assigned
      values are amortized on a basis which matches the periods in which those cash
      flows are estimated to be produced. The Company continually evaluates whether
      events or circumstances have occurred that indicate that the estimated remaining
      useful life of its intangible assets may warrant revision or that the carrying
      value of these assets may be impaired. To compute whether intangible assets
      with
      finite lives have been impaired, the estimated undiscounted future cash flows
      for the estimated remaining useful life of the assets are compared to the
      carrying value. To the extent that the future cash flows are less than the
      carrying value, the assets are written down to the estimated fair value of
      the
      asset. The Company determined the intangible assets were impaired at June 30,
      2007, and recorded an adjustment of $77,000.  The intangible assets
      were not considered to be impaired at June 30,  2006.






49




*Concentration
      of Credit Risk and Major Customers*




Financial
      instruments that potentially
      subject the Company to concentration of credit risk consist of trade
      receivables.





The
      Company grants credit to its
      customers, primarily large corporations in the medical device and semiconductor
      industries and the U.S. government. The Company performs periodic evaluations
      of
      customer’s payment history and generally does not require collateral.
      Receivables are generally due within thirty days. Credit losses have
      historically been minimal, which is consistent with management’s expectations.
      Allowances are provided for estimated amounts of accounts receivable which
      may
      not be collected. The Company has no significant off-balance sheet risk such
      as
      foreign-exchange contracts, option contracts or other foreign hedging
      arrangements. The Company places its cash with financial institutions which
      it
      believes are of high credit quality.





The
      Company had one major customer with
      revenues in excess of 10% of the Company’s total revenues for the year ended
      June 30, 2007 and two in the years ended June 30, 2006 and 2005, respectively,
      that accounted for the following annual revenue:




2007
            
            
            2006
            
            
            2005Revenues
            
            
            %
                of Total Revenues
            
            
            Revenues
            
            
            %
                of Total Revenues
            
            
            Revenues
            
            
            %
                of Total RevenuesCompany
                A
            
            $
            2,817,000
            
            
            
            18
            %
            
            $
            3,478,000
            
            
            
            19
            %
            
            $
            2,020,000
            
            
            
            20
            %Company
                B
            
            
            703,000
            
            
            
            5
            %
            
            
            1,457,000
            
            
            
            8
            %
            
            
            1,586,000
            
            
            
            16
            %Company
                C
            
            
            158,000
            
            
            
            1
            %
            
            
            2,650,000
            
            
            
            15
            %
            
            
            -
            
            
            
            -




At
      June
      30, 2007, 2006 and 2005, one customer accounted for the following amounts of
      accounts receivable:





2007
            
            
            2006
            
            
            2005Accounts
                Receivable (1)
            
            
            %
                of
              Total
                A/R
            
            
            Accounts
                Receivable (1)
            
            
            %
                of
              Total
                A/R
            
            
            Accounts
                Receivable (1)
            
            
            %
                of
              Total
                A/RCompany
                A
            
            $
            189,000
            
            
            
            9
            %
            
            $
            362,000
            
            
            
            14
            %
            
            $
            843,000
            
            
            
            34
            %Company
                D
            
            $
            300,000
            
            
            
            14
            %
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -





(1)
      Contains billed and unbilled receivables








The
      following table details the changes
      in the Company’s allowance for uncollectible accounts:




**Year
                ended June 30,****2007**
            
            
            **2006**
            
            
            **2005**Beginning
                balance
            
            $
            113,000
            
            
            $
            110,000
            
            
            $
            75,000Bad
                debt expense (recoveries)
            
            
            (10,000
            )
            
            
            32,000
            
            
            
            49,000Charges
                against the allowance
            
            
            (4,000
            )
            
            
            (29,000
            )
            
            
            (14,000
            )Ending
                balance
            
            $
            99,000
            
            
            $
            113,000
            
            
            $
            110,000





*Employee
      Stock-Based
      Compensation*




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






50






Prior
      to July 1, 2005, as was permitted
      under SFAS No. 123, the Company accounted for stock-based awards using the
      intrinsic value method under APB No. 25. In general, pursuant to APB No. 25,
      when the exercise price of options granted to employees and non-employee
      directors under these plans equals the market price of the underlying stock
      on
      the date of the grant, no compensation expense was recorded.





Effective
      July 1, 2005, the Company
      adopted SFAS 123R. The Company selected the modified prospective method of
      adoption in which compensation cost is recognized beginning with the effective
      date for all share-based payments to employees after June 30, 2005 and any
      unvested share-based payments to employees as of the effective date of adoption.
      In accordance with the modified prospective method of adoption, the Company’s
      results of operations for prior periods have not been restated.





The
      following table illustrates the
      effect on net loss applicable to common shareholders and net loss per share
      applicable to common shareholders as if the fair value method had been applied
      to all outstanding and unvested awards in the period ended June 30,
      2005:





**Years
                  Ended June 30, 2005**Net
                  loss applicable to common shareholders, as reported
              
              $
              (8,588,000
              )Add:
                  stock-based employee compensation expense included in reported
                  net loss
                  applicable to common shareholders, net of tax
              
              
              279,000Deduct:
                  total stock-based employee compensation expense determined
                under
                  the fair value based method of all awards, net of tax
              
              
              (1,843,000
              )Pro
                  forma net loss applicable to common shareholders
              
              $
              (10,152,000
              )Net
                  loss per share applicable to common shareholders, basic and
                  diluted:As
                  reported
              
              $
              (0.91
              )Proforma
              
              $
              (1.08
              )








The
      total non-cash stock-based
      compensation expense included in the consolidated statement of operations for
      the years ended June 30, 2007, 2006 and 2005, is included in the following
      expense categories:




**Years
                Ended****2007**
            
            
            **2006**
            
            
            **2005**Cost
                of revenues
            
            $
            194,000
            
            
            $
            540,000
            
            
            $
            2,000Research
                and development
            
            
            94,000
            
            
            
            122,000
            
            
            
            241,000Selling,
                general and administrative
            
            
            668,000
            
            
            
            1,572,000
            
            
            
            135,000Total
            
            $
            956,000
            
            
            $
            2,234,000
            
            
            $
            378,000




The
      fair value of each option award is
      estimated on the modified grant date using the Black-Scholes option pricing
      model using the assumptions noted in the following table. Expected volatility
      is
      based on historical volatility of the Company’s common stock. The Company uses
      historical data to estimate option forfeitures within the valuation model.
      The
      expected term of options granted is calculated using the “Simplified Method” as
      outlined in the Securities and Exchange Commission’s Staff Accounting Bulletin
      Topic 107 (“SAB 107”) and reflects the period of time that options granted are
      expected to be outstanding. The risk-free rate for periods within the
      contractual life of the option is based on the U.S Treasury yield curve in
      effect at the time of grant.






51






**Stock
                Option Plans**
            
            
            **Stock**
              **Purchase
                Plan****2007**
            
            
            **2006**
            
            
            **2005**
            
            
            **2007**Risk
                free interest rate
            
            
            4.58–5.07
            %
            
            
            3.72%-4.89
            %
            
            
            4.10%-4.73
            %
            
            
            5.07%-5.17
            %Expected
                dividend yield
            
            
            0
            %
            
            
            0
            %
            
            
            0
            %
            
            
            0
            %Expected
                lives (years)
            
            3.5
                - 6 years
            
            
            2.5
                - 6 years(1)
            
            
            5
                -
                10 years
            
            
            6
                monthsExpected
                volatility
            
            
            76%-79
            %
            
            
            68%-81
            %
            
            
            62%-68
            %
            
            
            78
            %Expected
                forfeiture rate
            
            
            10
            %
            
            
            4
            %
            
            
            0
            %
            
            
            0
            %Contractual
                term
            
            5
                -
                10 years
            
            
            5
                -
                10 years
            
            
            5
                -
                10 years
            
            
            6
                months






(1)
            The
                estimate of an option’s expected life has been updated and revised for all
                grants outstanding prior to adoption based upon guidance provided
                under
                SFAS 123R and SAB 107.




*Revenue
      Recognition*




The
      Company recognizes revenue when
      there is persuasive evidence of an arrangement with the customer which states
      a
      fixed or determinable price and terms, delivery of the product has occurred
      or
      the service performed in accordance with the terms of the sale, and
      collectibility of the related receivable is reasonably assured. The Company
      provides for estimated returns at the time of shipment based on historical
      data.
      Shipping costs charged to the customer are include in revenues and are not
      significant.




Contract
      revenue under cost-sharing
      research and development agreements is recognized as eligible research and
      development expenses are incurred. The Company’s obligation with respect to
      these agreements is to perform the research on a best-efforts
      basis.




Treatment
      systems planning revenues
      consists of sales of software licenses and maintenance agreements, product
      related training, installation, and consulting, and the associated hardware.
      Revenue from sales of software licenses and maintenance agreements is recognized
      ratably over the maintenance contract period, which is generally one year,
      pursuant to the guidance provided by Statement of Position (“SOP”) 97-2,
“*Software Revenue Recognition*” (SOP 97-2), issued by the American
      Institute of Certified Public Accountants (AICPA). Revenue from training,
      installation, consulting services and the associated hardware are recognized
      as
      the services are performed or product is delivered, provided there is vendor
      specific objective evidence (VSOE) of fair value which is the price charged
      when
      the services are sold separately. Revenues from treatment planning systems
      is
      included in medical revenues totaled $49,000 and $121,000 in fiscal 2007 and
      2006 respectively.  Revenue from treatment planning systems was
      immaterial in 2005.




Deferred
      revenues are recorded when the
      Company receives payments for product or services for which it has not yet
      completed its obligation to deliver product or has not completed services
      required by contractual agreements.




*Accounts
      Receivable*





Contract
      revenue under cost sharing
      research and development agreements is recognized as eligible expenses are
      incurred. Invoicing of research and development contracts occurs in accordance
      with the terms of the contract. Revenue recognized but unbilled is recorded
      as
      unbilled accounts receivable. At June 30, 2007 and  2006, unbilled
      accounts receivable represented approximately 8% and 1% of total accounts
      receivable. Generally, there are no prerequisites necessary to
      invoice.








*Research
      and Development Costs*





All
      costs of research and development
      activities are expensed as incurred. The Company performs research and
      development for itself and under contracts with others, primarily the U.S.
      government. In addition, periodically, the Company may continue its research
      on
      such projects at its own expense. These costs are considered Company funded
      research and development. Customer funded research and development is considered
      cost of revenues.






52






The
      Company funded and customer
      reimbursed research and development costs were as follows:




**Years
                ended June 30,****2007**
            
            
            **2006**
            
            
            **2005**Company
                funded
            
            $
            1,
                844,000
            
            
            $
            1,313,000
            
            
            $
            1,942,000Customer
                funded
            
            
            2,039,000
            
            
            
            2,775,000
            
            
            
            1,691,000Total
                research and development
            
            $
            3,883,000
            
            
            $
            4,088,000
            
            
            $
            3,633,000





*Software
      Development Costs*





The
      Company accounts for software
      development costs in accordance with SFAS No. 86, “*Accounting for the Costs
      of Computer Software to Be Sold, Leased or Otherwise Marketed*.”
Accordingly, the costs for the development of new software and substantial
      enhancements to existing software are expensed as incurred until technological
      feasibility has been established, at which time, any additional costs are
      capitalized. The Company believes technological feasibility has been established
      at the time at which a working model of the software has been completed and
      costs eligible for capitalization have been immaterial.





*Earnings
      (Loss) per Share*





Basic
      earnings (loss) per share is
      computed based only on the weighted average number of common shares outstanding
      during the period. Diluted earnings per share is computed by using the weighted
      average number of common shares outstanding during the period, plus the dilutive
      effects of shares issuable through the exercise of stock options (common stock
      equivalents) unless their inclusion would be antidilutive. In calculating
      diluted earnings per share, the dilutive effect of stock options and warrants
      is
      computed using the average market price for the period. Basic and diluted net
      loss per share available for common shareholders is the same for all periods
      presented as outstanding common stock options and warrants have been excluded
      because they are antidilutive.





The
      Company had the following potential
      dilutive securities outstanding on June 30, 2007: options and warrants to
      purchase 1,790,738 and 2,593,267 shares, respectively, of the Company’s common
      stock at weighted average exercise prices of $4.66 and $5.60 per share,
      respectively and (ii) Series D Preferred Stock convertible into an aggregate
      of 949,157 shares of the Company’s common stock. Such potential dilutive
      securities were not included in the calculation of diluted loss per share in
      2007 because the inclusion thereof would be antidilutive.





The
      Company had the following potential
      dilutive securities outstanding on June 30, 2006: options and warrants to
      purchase 1,836,551 and 1,756,228 shares, respectively, of the Company’s common
      stock at weighted average exercise prices of $5.41 and $7.68 per share,
      respectively and (ii) Series D Preferred Stock convertible into an aggregate
      of
      949,157 shares of the Company’s common stock. Such potential dilutive securities
      were not included in the calculation of diluted loss per share in 2006 because
      the inclusion thereof would be antidilutive.





The
      Company had the following potential
      dilutive securities outstanding on June 30, 2005: options and warrants to
      purchase 1,908,331 and 2,324,389 shares, respectively, of the Company’s common
      stock at weighted average exercise prices of $5.66 and $9.53 per share,
      respectively. Such potential dilutive securities were not included in the
      calculation of diluted loss per share in 2005 because the inclusion thereof
      would be antidilutive.




*Advertising
      Costs*





Advertising
      costs are expensed when
      incurred within selling, general and administrative expense. Advertising costs
      were immaterial for the years ended June 30, 2007, 2006 and 2005.






53






*Shipping
      and Handling*




The
      Company accounts for its shipping
      and handling cost within its cost of revenues.





*Recent
      Accounting Pronouncements*




In
      June
      2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation (“FIN”) No. 48, "*Accounting for Uncertainty in Income
      Taxes*", which clarifies the accounting for uncertainty in income taxes
      recognized in an enterprise's financial statements in accordance with Statement
      of Financial Accounting Standards (“SFAS”) No. 109, "*Accounting for Income
      Taxes*." FIN No. 48 establishes a recognition threshold and measurement
      attribute for the financial statement recognition and measurement of a tax
      position taken or expected to be taken in a tax return. This interpretation
      also
      provides guidance on derecognition, classification, interest and penalties,
      accounting in interim periods, disclosure and transition. FIN No. 48 is
      effective for fiscal years beginning after December 15, 2006. The adoption
      of
      FIN 48 is not expected to have a material impact on the Company’s consolidated
      financial statements.






In
      September 2006, the FASB issued SFAS No. 157, "*Fair Value
      Measurements*." This new standard provides guidance for using fair value to
      measure assets and liabilities. The FASB believes SFAS No. 157 also responds
      to
      investors' requests for expanded information about the extent to which companies
      measure assets and liabilities at fair value, the information used to measure
      fair value, and the effect of fair value measurements on earnings. SFAS No.
      157
      applies whenever other standards require (or permit) assets or liabilities
      to be
      measured at fair value but does not expand the use of fair value in any new
      circumstances. SFAS No. 157 is effective for fiscal years beginning after
      November 15, 2007. The Company is currently evaluating the provisions of this
      standard and is not certain of the potential impact at this time.




In
      December 2006, the FASB issued Staff Position No. EITF 00-19-2 ("FSP"). This
      FSP
      addresses an issuer's accounting for registration payment arrangements and
      specifies that the contingent obligation to make future payments or otherwise
      transfer consideration under a registration payment arrangement should be
      separately recognized and measured in accordance with FASB No. 5. The guidance
      in this FSP amends FASB Statements 133 and 150 and FASB Interpretation No.
      45 to
      include scope exceptions for registration payment arrangements. This FSP further
      clarifies that a financial instrument subject to a registration payment
      arrangement should be accounted for without regard to the contingent obligation
      to transfer consideration pursuant to the registration payment arrangement.
      This
      guidance is effective for financial statements issued for fiscal years beginning
      after December 15, 2006. The Company has adopted this FSP in the current fiscal
      year ending June 30, 2007. The Company's adoption of this FSP in the current
      fiscal year has not had a material effect on its financial position, operations
      or cash flow.




In
      February 2007, the FASB issued SFAS No. 159, “*The Fair Value Option for
      Financial Assets and Financial Liabilities”*, which provides companies with
      an option to report selected financial assets and liabilities at fair value.
      The
      objective of SFAS No. 159 is to reduce both complexity in accounting for
      financial instruments and the volatility in earnings caused by measuring related
      assets and liabilities differently. SFAS No. 159 establishes presentation and
      disclosure requirements designed to facilitate comparisons between companies
      that choose different measurement attributes for similar types of assets and
      liabilities and to more easily understand the effect of the company’s choice to
      use fair value on its earnings. SFAS No. 159 also requires entities to display
      the fair value of the selected assets and liabilities on the face of the balance
      sheet. SFAS No. 159 does not eliminate disclosure requirements of other
      accounting standards, including fair value measurement disclosures in SFAS
      No.
      157. This Statement is effective as of the beginning of an entity’s first fiscal
      year beginning after November 15, 2007. Early adoption is permitted as of the
      beginning of the previous fiscal year provided that the entity makes that choice
      in the first 120 days of that fiscal year and also elects to apply the
      provisions of Statement No. 157. Adoption of SFAS No. 159 is not expected to
      have a material impact on the Company’s results of operations or financial
      position.






54





**3.**
              **Discontinued
                  Operations**
 
 On
        May
        1,2007,
        the Company completed the sale of its Accurel Division to EAG (“Asset Sale”).
        The Asset Sale was completed in accordance with the terms and conditions
        of the
        Purchase Agreement. As consideration for the Asset Sale, the Company received
        cash proceeds of approximately $12,705,000 of which $1,000,000 was placed
        in
        escrow. At June 30, 2007, the Company determined that the proceeds, less
        the
        related transaction costs of approximately $1,794,000 in cash fees and expenses,
        taxes of $197,000, and $390,000 in a non-cash charge for three year warrants
        issued, were less than the book value of the net assets transferred of
        $11,570,000 and therefore a loss on the sale of Accurel of $1,246,000 was
        recorded in the year ended June 30, 2007 as a component of the loss from
        discontinued operations in the accompanying statement of operations. On May
        1,
        2007, the Company recognized a loss of $487,000, which represents the amounts
        due under the Accurel facility lease in excess of amounts to be received
        from
        sublease rentals.  The facility lease, which will remain an obligation of
        the Company, expires in 2010.
 
 In
        accordance with Statement of Financial Accounting Standards No.144, “Accounting
        for the Impairment or Disposal of Long-Lived Assets”, the June 30, 2007
        financial statements have been prepared and historical statements of operations
        have been reclassified to present the results of Accurel as discontinued
        operations. As noted above, the Company had formally committed to a plan
        to sell
        Accurel in March 2007 and finalized that plan at the closing on May 1, 2007.
        The
        Company has clearly (i) eliminated Accurel’s financial results from its ongoing
        operations, (ii) determined that Accurel, as operated as a separate subsidiary
        was a separate component of its aggregated business as, historically, management
        reviewed separately the Accurel financial results and cash flows apart from
        its
        ongoing continuing operations, and (iii) determined that it will have no
        further
        continuing involvement in the operations of Accurel after the sale.
 
 Condensed
        results of operations
        relating to Accurel for the years ended June 30, 2007, 2006 and 2005 are
        as
        follows:
 
 **Years
                  Ended June 30,****2007**
              
              
              **2006**
              
              
              **2005**Revenues:
              
              $
              7,561,000
              
              
              $
              8,317,000
              
              
              $
              2,274,000Gross
                  profit
              
              
              2,238,000
              
              
              
              2,728,000
              
              
              
              755,000Operating
                  income
              
              
              482,000
              
              
              
              1,021,000
              
              
              
              168,000Loss
                  on sale of Accurel
              
              
              (1,246,000
              )
              
              
              -
              
              
              
              -Income
                  (loss) from   discontinued operations
              
              $
              (764,000
              )
              
              $
              1,021,000
              
              
              $
              168,000
  **4.            Acquisitions**
 
 **Core
        Systems Incorporated**
  On
        October 15, 2004, the Company
        completed the acquisition of Core Systems Incorporated (“Core”), a privately
        held semiconductor wafer processing company. The transaction was structured
        as a
        reorganization of Core with and into a newly formed, wholly-owned subsidiary
        of
        the Company. The operating results of Core Systems have been included in
        the
        Company’s statement of operations beginning October 15, 2004.
  The
        aggregate purchase price of
        Core was $7,486,000, which consisted of $2,000,000 in cash; 311,437 shares
        of
        the Company's common stock with an aggregate fair value of $3,250,000; direct
        acquisition costs of approximately $1,726,000 and the payment of approximately
        $510,000 of debt and other obligations coincident with the closing which
        were
        paid by issuing 48,875 shares of the Company’s common stock. The number of
        shares issued was initially determined by the average price of the Company’s
        stock over a twenty day period ending October 8, 2004. The share price was
        subject to adjustment limiting the gain or loss in the value of the Company
        stock, over a twenty day period at the end of a six month lock-up, ending
        April
        15, 2005, to 25% from the initial value. The twenty day average price of
        the
        stock for the period ending April 15, 2005 was $5.75 which resulted in the
        need
        to issue an additional 112,475 shares. These shares were issued in August
        2005.
        The fair value of the Company's common stock was determined based on the
        average
        market price of the Company's common stock over a period of time before October
        15, 2004, the date fair value is to be determined, pursuant to Emerging Issues
        Task Force ("EITF") Issue No. 99-12, “Determination of the Measurement Date
        for the Market Price of Acquirer Securities Issued in a Purchase Business
        Combination.” In addition the purchase was subject to an earn-out, payable in
        Company stock, which if earned would be accounted for as additional purchase
        price. The earn-out period measurement date was October 14, 2005. No earn
        out
        payments became due.
 
 55
 
 
 Core
                  Purchase PriceCash
              
              $
              2,000,000Common
                  stock
              
              
              3,250,000Common
                  stock used to retire debt
              
              
              510,000Warrant
              
              
              1,122,000Direct
                  costs
              
              
              604,000$
              7,486,000
 
 The
        following table summarizes the
        allocation of the purchase price to the fair value of the assets acquired
        and
        liabilities assumed at the date of acquisition:
 
 October
                  15, 2004Accounts
                  receivable
              
              $
              518,000Inventory
              
              
              174,000Property
                  and equipment
              
              
              3,422,000Other
                  intangible assets
              
              
              335,000Goodwill
              
              
              4,647,000Other
                  assets
              
              
              74,000Accounts
                  payable and accrued expenses
              
              
              (1,063,000
              )Debt
                  and capital leases
              
              
              (621,000
              )$
              7,486,000
  The
        allocation of purchase price is the
        responsibility of management. The Company considered a number of factors,
        including professional appraisals, for the valuation of equipment acquired,
        in
        making its purchase price allocation determination. The acquisition of Core
        resulted in goodwill of $4,647,000. The Company also identified $335,000
        of
        intangible assets with finite lives. The intangible assets are being amortized
        over a period of sixty months, the estimated useful lives of the assets,
        from
        the date of acquisition, October 15, 2004. Amortization expense for the year
        ended June 30, 2007, 2006 and 2005 related to these intangible assets was
        $66,000, $66,000 and $47,000, respectively. In fiscal 2007 and 2006, after
        performing its annual assessment of goodwill and other intangible assets,
        management recorded impairment charges of $3,829,000 and $457,000, respectively,
        against the goodwill and long lived assets attributable to the semiconductor
        services reporting unit.   These charges are reflected in the
        statement of operations for the years ended June 30, 2007 and 2006.
  The
        acquisition of Core is accounted
        for as a purchase under SFAS No. 141, “Business Combinations.” Accordingly,
        the operating results of Core are included in the accompanying consolidated
        financial statements since the acquisition date as part of the Company's
        semiconductor reporting segment.
  The
        following table presents selected
        unaudited financial information of the Company including Core Systems
        Incorporated as if the acquisition had occurred on July 1, 2004.  The
        unaudited pro forma results are not necessarily indicative of the results
        that
        would have occurred had the acquisition of Core Systems been consummated
        on July
        1, 2004, or of future results.
 
 Year
                  ended
                June
                  30, 2005Revenues
              
              $
              11,299,000Loss
                  from operations
              
              
              (7,736,000
              )Net
                  loss
              
              
              (7,943,000
              )Preferred
                  distribution, dividends and accretion
              
              
              (1,183,000
              )Net
                  loss applicable to common shareholders
              
              $
              (9,126,000
              )Net
                  loss per share applicable to common shareholders, basic and
                  diluted
              
              $
              (0.90
              )Weighted
                  average common shares outstanding, basic and diluted
              
              
              10,168,743
 
 
 
 56
 
 **5.           Inventories**
 
 Inventories
        consist of the
        following:
 
 **June
                  30,****2007**
              
              
              **2006**Raw
                  materials
              
              $
              737,000
              
              
              $
              965,000Work-in-progress
              
              
              94,000
              
              
              
              291,000Finished
                  goods
              
              
              335,000
              
              
              
              276,000$
              1,166,000
              
              
              $
              1,532,000
  The
        allowance for excess and
        obsolete inventory was $293,000, $356,000, and $204,000 as of June 30, 2007,
        2006 and 2005, respectively.
 
 **Year
                  ended June 30,****2007**
              
              
              **2006**
              
              
              **2005**Beginning
                  balance
              
              $
              356,000
              
              
              $
              204,000
              
              
              $
              81,000Additional
                  expense
              
              
              302,000
              
              
              
              212,000
              
              
              
              204,000Charges
                  against the allowance
              
              
              (365,000
              )
              
              
              (60,000
              )
              
              
              (81,000
              )Ending
                  balance
              
              $
              293,000
              
              
              $
              356,000
              
              
              $
              204,000
 
 **6.           Property
        and
        Equipment**
 
 Property
        and equipment consists of the following**:**
  **June
                  30,****2007**
              
              
              **2006**Machinery
                  and equipment
              
              $
              8,290,000
              
              
              $
              10,022,000Construction
                  in progress
              
              
              53,000
              
              
              
              679,000Computers
                  and software
              
              
              791,000
              
              
              
              769,000Leasehold
                  improvements
              
              
              459,000
              
              
              
              445,000Furniture
                  and fixtures
              
              
              190,000
              
              
              
              190,000Equipment
                  under capital lease
              
              
              43,000
              
              
              
              43,000Total
                  property and equipment
              
              
              9,826,000
              
              
              
              12,148,000Less:
                  accumulated depreciation and amortization
              
              
              (6,904,000
              )
              
              
              (6,303,000
              )$
              2,922,000
              
              
              $
              5,845,000
 
 The
        Company recorded depreciation
        expense of approximately $1,467,000, $1,411,000 and $1,332,000 for the years
        ended June 30, 2007, 2006 and 2005, respectively. Depreciation expense for
        the
        period ended June 30, 2007, includes an adjustment of approximately $866,000
        of
        accumulated depreciation related to the disposal of certain capital equipment
        associated with the orthopedic coatings and brachytherapy product
        groups.  Included in the June 30, 2007 balance is an adjustment for
        the impairment of certain fixed assets associated with the semiconductor
        services reporting unit (see note 18) Equipment purchased pursuant to capital
        leases and leasehold improvements are amortized based upon the lesser of
        the
        term of the lease or the useful life of the asset and such expense is included
        in depreciation expense.
 
 57
 
 **7.            
        Accrued
        Expenses**
 
 Accrued
        expenses consist of the following:
 
 **June
                  30,**
              
              
              **June
                  30,****2007**
              
              
              **2006**Accrued
                  compensation and benefits
              
              $
              555,000
              
              
              $
              602,000Accrued
                  costs related to acquisitions
              
              
              -
              
              
              
              304,000Accrued
                  taxes
              
              
              478,000
              
              
              
              -Other
                  accrued liabilities
              
              
              1,065,000
              
              
              
              741,000$
              2,098,000
              
              
              $
              1,647,000
 
 The
        Company accrues warranty costs in the period the related revenue is recognized
        and adjusts the reserve balance as needed to address potential future
        liabilities.  The following table details the changes in the Company’s
        warranty reserve, which is included in other accrued liabilities in the schedule
        above.
  **June
                  30,**
              
              
              **June
                  30,****2007**
              
              
              **2006**Beginning
                  balance
              
              $
              66,000
              
              
              $
              66,000Accrued
                  warranty expense
              
              
              25,000
              
              
              
              133,000Charges
                  against the reserve
              
              
              (34,000
              )
              
              
              (133,000
              )Ending
                  balance
              
              $
              57,000
              
              
              $
              66,000
 
 **8.           Investment
        in Unconsolidated
        Subsidiaries**
 
 In
        March 2004, the Company entered into
        an Exchange & Venture Agreement with CardioTech International, Inc.
        (“CardioTech”), a public company and related party of the Company, and CorNova,
        Inc. (“CorNova”) (Note 10). CorNova is a start-up company incorporated as a
        Delaware corporation on October 12, 2003. CorNova’s focus is the development and
        marketing of innovative interventional cardiology products. The Company has
        determined that its technology may have applications in CorNova’s products. In
        connection with the agreement, in March 2004, the Company and CardioTech
        issued
        10,344 and 12,931 shares, respectively, of their respective common stock
        (the
“Contributory Shares”) bearing an aggregate fair market value of $113,000 and
        $76,000, respectively, as of the date of the issuance. In exchange, the Company
        and CardioTech each received 1,500,000 shares of CorNova’s common stock, which
        represented a 30% ownership position for each party. In February 2005, upon
        CorNova’s securing of an additional $3,000,000 in financing (“Series A”),
        CardioTech and the Company each issued additional shares of their common
        stock
        (the “Investment Shares”), which was equal in value to twenty-five percent (25%)
        of the gross proceeds of the Series A Financing, or $750,000. The Company
        and
        CardioTech issued 76,687 and 308,642 additional shares of their common stock,
        respectively.  As of June 30, 2007, and 2006, the Company’s shares
        represent a 16.2% and 18%, respectively, ownership position in CorNova, and
        had
        a position on the Board of Directors.
 
 Both
        the Contributory Shares and the
        Investment Shares (collectively, the “Securities”) are restricted securities
        within the meaning of Rule 144 of the Securities and Exchange Commission
        under
        the Securities Act of 1933, as amended (the “Securities Act”) and none of the
        Securities may be sold except pursuant to an effective registration statement
        under the Securities Act or under the securities laws of any state, or in
        a
        transaction exempt from registration under the Securities Act.
  The
        Company is accounting for this
        investment under the equity method pursuant to APB Opinion No. 18, “The Equity
        Method of Accounting for Investments in Common Stock.” As of June 30, 2007 and
        2006, 87,031 shares have been issued to CorNova by the Company. These shares
        represent an approximate 16.2% and 18% of the shares issued, respectively.
 
 
 58
 
 For
        the years ended June 30, 2007,
        2006, and 2005, the Company recognized approximately $158,000, $359,000,
        and
        $75,000, respectively, of equity losses in unconsolidated subsidiaries,
        representing the Company’s portion of CorNova’s net loss. The Company also
        recorded approximately $16,000 as an unrealized loss, $2,000 as an unrealized
        gain in 2006 and $78,000 as unrealized loss for the year ended June 30,
        2005.  Gains and losses are recorded as other comprehensive income in
        the equity section of the Company’s financial statements.  As of June
        30, 2007, CorNova sold its holding of the Company’s stock.  As a
        result, 16,449 shares of stock previously categorized as treasury stock has
        been
        reclassified to additional paid in capital in the accompanying balance
        sheet.
 
 As
        a
        result of the cumulative net losses incurred, the Company’s investment in
        CorNova is $0.  No further writedowns will be incurred unless CorNova
        has cumulative net income sufficient to offset the cumulative net
        losses.
 
 CorNova’s
        unaudited results for the
        twelve month periods ended were as follows:
 
 **Period
                  Ended June 30**,**2007**
              
              
              **2006**
              
              
              **2005**Revenue
              
              $
              -
              
              
              $
              92,000
              
              
              $
              34,000Expenses
              
              
              (3,180,000
              )
              
              
              (2,201,000
              )
              
              
              (646,000
              )Loss
                  on sale of securities
              
              
              (1,067,000
              )
              
              
              -
              
              
              
              -Income
                  tax benefit
              
              
              260,000
              
              
              
              180,000
              
              
              
              240,000Net
                  loss
              
              $
              (3,987,000
              )
              
              $
              (1,929,000
              )
              
              $
              (372,000
              )
 
 CorNova
        is developing a series of
        coronary stents used in angioplasty procedures.  The ultimate goal is to
        market and sell a new drug eluting stent based on proprietary technology
        provided, in part, by the Company and CardioTech and distributed
        worldwide.  The first part of the plan is to market a new
        Cobalt-Chrome stent which has recently undergone animal testing.  Data
        on these tests are scheduled to be released in late calendar 2007.
 
 **9.           Research
        and Development
        Arrangements**
 
 The
        Company is the recipient of several
        grants under the U.S. Government’s Small Business Innovative Research (SBIR)
        Program. These grants from the National Institute of Health are firm-fixed
        priced contracts and generally range in length from six to twenty-four months.
        Contracts received from the Department of Defense are both firm-fixed price
        and
        cost-plus type programs and also range from six to twenty-four months. Revenues
        under such arrangements were approximately $2,817,000, $3,478,000, and
        $1,738,000 for the years ended June 30, 2007, 2006, and 2005, respectively.
        Revenues earned under these contracts are recognized in the appropriate business
        segment.
  **Year
                  ended June 30,**Segment
              
              **2007**
              
              
              **2006**
              
              
              **2005**Medical
              
              $
              394,000
              
              
              $
              365,000
              
              
              $
              444,000Semiconductor
              
              
              -
              
              
              
              -
              
              
              
              -Security
                  products
              
              
              2,423,000
              
              
              
              3,113,000
              
              
              
              1,294,000Total
              
              $
              2,817,000
              
              
              $
              3,478,000
              
              
              $
              1,738,000
 
 Unbilled
        accounts receivable relating
        to such arrangements was approximately $162,000 and $21,000  at June
        30, 2007 and  2006 respectively.
 
 **10.           Related
        Party
        Transactions**
 
 SFAS
        No. 57, “Related Party
        Disclosures,” specifies the nature of information that should be disclosed in
        financial statements regarding related party transactions. CardioTech, a
        publicly traded company whose common stock trades under the symbol CTE on
        the
        American Stock Exchange, is a related party with the Company by virtue of
        its
        significant business relationships.
  
 59
 
 Certain
        directors of the Company hold
        positions as directors of CardioTech. The former CEO and current Chairman
        of the
        Board of Directors of the Company is also a director of CardioTech.
  In
        March 2000, the Company entered into
        a joint research agreement with CardioTech to develop a proprietary porous
        polymer biocompatible coating technology as a platform for the Company’s
        proprietary radioactive brachytherapy technology. In consideration for this
        agreement, the Company agreed to pay $150,000 in cash and purchase 100,000
        shares of CardioTech stock at a price of $1.00 per share. As of June 30,
        2007,
        the fair market value of these shares, which is $133,000, is recorded as
        investments in available for sale securities in the accompanying consolidated
        balance sheet. The unrealized holding gains and losses are recorded as
        accumulated other comprehensive income (loss) within stockholders’
equity.
  In
        March 2004, the Company entered into
        an Exchange & Venture Agreement with CardioTech and CorNova (Note 8).
  **11.           Commitments
        and
        Contingencies**
  (a)
        Capital and Operating
        Leases
  The
        Company has an operating lease for
        its manufacturing, research and office space in Wakefield, MA which expires
        on
        December 31, 2008. The Company has an option to extend the lease for five
        additional years. Under the terms of the lease, the Company is responsible
        for
        its proportionate share of real estate taxes and operating expenses relating
        to
        this facility. The Company also has leases for both of its facilities in
        Sunnyvale, CA. The leases expire in December 2009 and September 2010 and
        the
        Company has an option to extend each lease for five additional
        years.  Effective with the sale of the assets of Accurel Systems on
        May 1, 2007, the Company executed a sublease agreement for one of its California
        facilities and terminated the lease for its satellite facility in Austin,
        TX.  Total rental expense, including maintenance and real estate tax
        expenses, for the fiscal years ended June 30, 2007, 2006 and 2005 was
        $1,356,000, $1,423,000 and $1,195,000, respectively.
 
 In
        conjunction with the acquisition of
        Accurel, the Company recorded a lease liability of $829,000. This liability
        reflected management’s estimate of the excess of payments required under the
        Accurel facility lease, at the date of acquisition, versus the fair market
        value
        of lease payments that would have been required, if the lease had been
        negotiated under current market conditions.  Subsequently, as a result
        of the sale of Accurel, the Company has recorded an additional lease liability
        of $487,000 representing that portion of the lease in excess of the sublease
        arrangement with Evans.  The balance of the lease liability on June
        30, 2007 is $1,036,000, of which $301,000 is current.  Under the terms
        of the leases, the Company is responsible for its proportionate share of
        real
        estate taxes and operating expenses relating to these facilities.
  Future
        minimum rental payments required
        under capital leases and operating leases with non-cancelable terms in excess
        of
        one year at June 30, 2007, together with the present value of net minimum
        lease
        payments are as follows:
  **Capital
                  Lease Payments**
              
              
              **Operating
                  Lease Payments (1)**
              
              
              **Sublease**
                **Income**Year
                  ending June 30:2008
              
              $
              29,000
              
              
              $
              1,461,000
              
              
              $
              245,0002009
              
              
              27,000
              
              
              
              1,201,000
              
              
              
              253,0002010
              
              
              15,000
              
              
              
              578,000
              
              
              
              260,0002011
                  and remaining
              
              
              2,000
              
              
              
              84,000
              
              
              
              65,000Total
                  future minimum lease payments
              
              $
              73,000
              
              
              $
              3,324,000
              
              
              $
              823,000Less:
                  amounts representing interest
              
              
              (8,000
              )Present
                  value of future minimum lease payments
              
              
              65,000Less:
                  current portion
              
              
              (24,000
              )Capital
                  lease obligation, net of current portion
              
              $
              41,000
 
 (1)
        adjusted for the effect of the sublease on the Lucerne Road
        facility
 
 60
 
 (b)           Employment
        Agreements
  On
        June 30, 2004, the Company entered
        into an employment agreement with Dr. Anthony J. Armini, the Company’s President
        and CEO, with an initial term of three years and an automatic renewal for
        a
        successive period of three years, unless the Company or Dr. Armini give the
        other party not less than three months written notice of non-renewal. Under
        this
        employment agreement, Dr. Armini serves as the Company’s president and chief
        executive officer at a base salary of up to $210,000 and is subject to increase
        as authorized by the Compensation Committee. In addition, Dr. Armini may
        participate in the Company’s employee fringe benefit plans or programs generally
        available to employees of comparable status and position. The Company is
        entitled to terminate his employment for any material breach of his employment
        agreement at any time upon at least 30 days’ written notice. In the event the
        Company terminates Dr. Armini’s employment without cause, the Company will pay
        him 12 months salary. Under his employment agreement, he is subject to
        restrictive covenants, including confidentiality provisions. Also, during
        his
        employment and for a period of two years after the term of the employment
        agreement, Dr. Armini is subject to a non-competition provision.
 
 On
        September 27, 2007, the Company and Dr. Armini entered into a Transition
        Agreement with a term of twenty four months.  Under this Transition
        Agreement Dr. Armini stepped down as President and Chief Executive Officer
        and
        assumed the position of Scientific Advisor.  Dr. Armini will remain
        the Chairman of the Board of Directors until the next annual meeting of
        shareholders.  During the Transition Period, the Company will
        compensate Dr. Armini at the annual rate of $250,000.  In addition,
        Dr. Armini may participate in the Company’s medical and dental insurance
        programs.  The Company may terminate this Transition Agreement only
        for cause and Dr. Armini may terminate the Transition Agreement for any reason,
        with each party giving the other written notice.  In conjunction with
        this, Dr. Armini has been issued a stock option for 200,000 at an exercise
        price
        of $2.09 per share, of which 25,000 shares vest immediately, and the remaining
        175,000 shares vest 25,000 per quarter over the term of the Transition
        Agreement.
  On
        June 30, 2004, the Company entered
        into an employment agreement with Dr. Stephen Bunker, the Company’s Vice
        President and Chief Scientist, with an initial term of three years and an
        automatic renewal for a successive period of three years, unless the Company
        or
        Dr. Bunker give the other party not less than three months written notice
        of
        non-renewal. Under this employment agreement, Dr. Bunker serves as the Company’s
        vice president and chief executive scientist at a base salary of up to $150,000,
        subject to increase as authorized by the Compensation Committee. In addition,
        Dr. Bunker may participate in the Company’s employee fringe benefit plans or
        programs generally available to employees of comparable status and position.
        The
        Company is entitled to terminate his employment for any material breach of
        his
        employment agreement at any time upon at least 30 days’ written notice. In the
        event the Company terminates Dr. Bunker’s employment without cause, the Company
        will pay him 12 months salary. Under his employment agreement, he is subject
        to
        restrictive covenants, including confidentiality provisions. Also, during
        his
        employment and for a period of two years after the term of the employment
        agreement, Dr. Bunker is subject to a non-competition provision.
 
 On
        October 15, 2004, the Company
        entered into an employment agreement with Walter J. Wriggins, the Company’s Vice
        President and General Manager of Core Systems, with an initial term of one
        year
        and an automatic renewal for a successive period of one year, unless the
        Company
        or Mr. Wriggins give the other party not less than thirty days written notice
        of
        non-renewal. Under this employment agreement, Mr. Wriggins serves as the
        Company’s vice president of business development/operations and general
        manager of Core Systems at a base salary of $140,000, subject to increase
        as
        authorized by the Compensation Committee. In addition, Mr. Wriggins may
        participate in the Company’s employee fringe benefit plans or programs generally
        available to employees of comparable status and position. The Company is
        entitled to terminate his employment for any material breach of his employment
        agreement at any time upon at least 30 days’ written notice. In the event the
        Company terminates Mr. Wriggins’ employment without cause, the Company will pay
        him the balance of the salary due for the term of the agreement. Under his
        employment agreement, he is subject to restrictive covenants, including
        confidentiality provisions. Also, during his employment and for a period
        of two
        years after the term of the employment agreement, Mr. Wriggins is subject
        to a
        non-competition provision
 
 On
        March
        12, 2007, the Company entered into an employment agreement with Phillip C.
        Thomas, the Company’s President and CEO, whereby should Mr. Thomas’ employment
        be terminated for reasons other than cause during his first year of service,
        he
        will be paid six months base salary in compensation and one year of base
        compensation after one year of service.
 
 
 61
 
 (c)           Litigation
  From
        time to time, we are subject to
        various claims, legal proceedings and investigations covering a wide range
        of
        matters that arise in the ordinary course of our business activities. Each
        of
        these matters is subject to various uncertainties.
 
 On
        March 23, 2005, we entered into a
        Development, Distribution and Manufacturing Agreement (the “Rapiscan Agreement”)
        with Rapiscan Systems, Inc. (“Rapiscan”).  Under the terms of this
        agreement, we gave Rapiscan the exclusive worldwide rights to market our
        Quantum
        SnifferTM portable
        and
        benchtop trace detection devices under their private label.  We also agreed
        to give Rapiscan the exclusive worldwide rights to distribute certain other
        new
        security products which we may develop in the future with their funding,
        as well
        as rights, in some circumstances, to manufacture certain components of the
        Quantum SnifferTM portable
        and
        benchtop trace detection devices.
 
 On
        March 24, 2006, the Company brought
        suit in the United States District Court in the District of Massachusetts
        against Rapiscan and its parent, OSI Systems, Inc. (“OSI”). The Company is
        requesting rescission of the Rapiscan Agreement, for lack of performance
        and
        other grounds. In the alternative, the Company is seeking termination of
        the
        Rapiscan Agreement due to material breaches of contract and implied covenant
        of
        good faith and fair dealing and for damages due to Rapiscan’s breach of contract
        and the implied covenant of good faith and fair dealing.
 
 On
        March 27, 2006, the Company received
        notice that Rapiscan filed a complaint against the Company and its contract
        manufacturer, Columbia Tech, in the United States District Court for the
        Central
        District of California, regarding the Rapiscan Agreement. Rapiscan’s complaint
        against the Company is based upon claims of breach of contract and breach
        of
        warranty and is requesting a decree for specific performance, declaratory
        relief
        and injunctive relief. Rapiscan’s complaint against Columbia Tech is based upon
        injunctive relief, declaratory relief and tortuous interference with contractual
        relations. On April 12, 2006, Rapiscan dismissed all claims against Columbia
        Tech.
 
 In
        August
        2006, as a result of motions made by both parties, the two lawsuits have
        been
        consolidated in the United States District Court for the Central District
        of
        California with the Company as plaintiff.  In late 2006, Rapiscan and
        OSI filed a motion to dismiss certain of the Company’s claims.  The
        court dismissed Company’s claim of breach of fiduciary duty, but OSI’s motion to
        dismiss was denied in all other respects.  The parties are presently
        near the end of the discovery process, which should be completed by November
        2007.  OSI and Rapiscan have filed motions for partial summary
        judgment with respect to certain discrete claims.  The motions are
        under advisement.  Trial is expected in the summer 2008.
 
 Should
        the Company be unsuccessful in prosecuting this matter, it may have a material
        adverse effect on its business and results of operations.  No revenue
        has been recorded related to the Rapiscan Agreement.
  On
        or about March 8, 2006, the Company
        commenced an arbitration under the Rules of the American Arbitration Association
        against Respondents Majid Ghafghaichi (“Majid”) and Vahe Sarkissisian (“Vahe”),
        (the “Respondents”) seeking a total of $3,994,000 for indemnification of various
“Losses,” as defined in, and expressly allowed pursuant to, a Stock Purchase
        Agreement dated March 9, 2005 (the “Agreement”), between the Company, as the
        purchaser, Accurel Systems International Corporation (“Accurel), and  the
        Respondents,  as the sellers of 100% of the issued and outstanding
        shares of Accurel stock.
 
 More
        specifically, there are four
        claims asserted by the Company against Respondents: (1) Damages of $3.4 million
        resulting from misrepresentations concerning the loss of business from a
        key
        Accurel customer; (2) unauthorized withdrawals in the amount of approximately
        $276,000 from Accurel by the Respondents prior to the closing; (3) approximately
        $49,000 of disallowed transaction expenses that the Respondents improperly
        received; and (4) undisclosed net liabilities totaling approximately
        $269,000.
 
 Respondents
        have asserted counterclaims
        seeking “an aggregate amount in excess of $1,750,000,” based on the allegedly
“late payment” to Respondents of Company stock and a Secured Promissory Note as
        part of the consideration for their sale of Accurel stock.  The Company has
        filed a detailed denial of all counterclaims.
 
 
 62
 
 On
        April 11, 2007, the Company and the
        Respondents executed a Settlement and Mutual Release Agreement dismissing
        the
        claims and counterclaims.  As a result of this settlement, the Company
        recorded a gain of approximately $201,000 in the fourth quarter as a result
        of
        reversing an accrual relating to this matter.  This adjustment is
        included in loss on sale of discontinued operations in the consolidated
        statements of operations for fiscal year 2007.
 
 We
        may, from time to time, be involved
        in other actual or potential proceedings that we consider to be in the normal
        course of our business. We do not believe that any of these proceedings will
        have a material adverse effect on our business.
 
 **12.           Income
        Taxes**
  A
        reconciliation of the federal
        statutory rate to the Company’s effective tax rate for the years ended June 30,
        2007, 2006 and 2005 are as follows:
 
 **2007**
              
              
              **2006**
              
              
              **2005**Income
                  tax provision (benefit) at federal statutory rate
              
              
              (34.0
              %)
              
              
              (34.0
              %)
              
              
              (34.0
              %)Increase
                  (decrease) in tax resulting fromState
                  tax provision, net of federal benefit
              
              
              (0.97
              %)
              
              
              (2.24
              %)
              
              
              (8.5
              %)Non-deductible
                  expenses
              
              
              14.8
              %
              
              
              11.48
              %
              
              
              1.9
              %Credits
                  and other, net
              
              
              (0.31
              %)
              
              
              -
              %
              
              
              -
              %Change
                  in valuation allowance
              
              
              20.48
              %
              
              
              24.76
              %
              
              
              40.6
              %Effective
                  income tax rate
              
              
              -
              %
              
              
              -
              %
              
              
              -
              %
  Significant
        components of the Company’s net deferred tax asset are as follows:
   ***Deferred
                  Tax Components*****2007**
              
              
              **2006**Deferred
                  tax assets:Net
                  operating loss and tax credit carryforwards
              
              $
              8,090,000
              
              
              $
              10,357,000Accrued
                  expenses
              
              
              453,000
              
              
              
              511,000Stock-based
                  compensation
              
              
              57,000
              
              
              
              -Amortization
                  of intangibles
              
              
              28,000
              
              
              
              35,000Net
                  deferred tax assets of discontinued operations
              
              
              734,000
              
              
              
              505,000Total
                  deferred tax assets
              
              
              9,362,000
              
              
              
              11,408,000Deferred
                  tax liabilities:Excess
                  depreciation
              
              
              1,037,000
              
              
              
              1,310,000Investment
                  in affiliates
              
              
              11,000
              
              
              
              87,000Net
                  deferred tax liabilities of discontinued operations
              
              
              44,000
              
              
              
              1,716,000Total
                  deferred tax liabilities
              
              
              1,092,000
              
              
              
              3,113,000Net
                  deferred tax assets
              
              
              8,270,000
              
              
              
              8,295,000Valuation
                  allowance
              
              
              (8,270,000
              )
              
              
              (8,295,000
              )Net
                  deferred tax asset
              
              $
              -
              
              
              $
              -
 
  A
        valuation allowance has been
        established for the Company’s tax assets as their use is dependent on the
        generation of sufficient future taxable income, which cannot be predicted
        at
        this time. Included in the valuation allowance is approximately $1,439,000
        related to certain operating loss carryforwards resulting from the exercise
        of
        employee stock options.
  
 63
 
 At
        June 30, 2007, the Company has the
        following unused net operating loss and tax credit carryforwards available
        to
        offset federal and state taxable income, both of which expire at various
        times
        through 2025.
 
 **Net
                  Operating Loss**
              
              
              **Investment,
                  AMT**
                **and
                  R & D Credits**
              
              **Expiration
                  Dates**Federal
              
              $
              18,089,000
              
              
              $
              441,000
              
              2020
                  to 2028State
              
              $
              22,445,000
              
              
              $
              316,000
              
              2008
                  to 2023
  The
        Company’s federal net operating
        loss carryforwards are subject to review and possible adjustment by the Internal
        Revenue Service and are subject to certain limitations in the event of
        cumulative changes in the ownership interest of significant stockholders
        over a
        three-year period in excess of 50%.
  **13.**           **Redeemable
        Convertible
        Preferred Stock**
 
 On
        July 6, 2005, the Company executed a
        $3.0 million secured term note payable to Laurus Master Fund, Ltd. (“Laurus”).
        The Company received $3,000,000 in gross proceeds, less a management fee
        of
        $135,000 and related transaction costs of approximately $32,000. The term
        note
        was collateralized by substantially all of the Company’s assets, had a 4-month
        term and bore interest at a rate equal to the prime rate plus one percent
        (1%).
        In connection with the financing, on September 30, 2005, the Company issued
        Laurus a warrant to purchase up to 250,000 shares of the Company’s common stock
        at a price equal to $3.75 per share. The warrants were valued using the Black
        Scholes model and the following assumptions: volatility of 67%, expected
        life of
        5 years and a risk free interest rate of 3.77%. Net proceeds from the financing
        were used for increasing the capacity of the Quantum SnifferTM production line,
        increasing unit inventories and the repayment of certain indebtedness due
        and
        owed by the Company to the former shareholders of Accurel in connection with
        the
        acquisition of this wholly-owned subsidiary.
  On
        September 30, 2005, the Company
        issued 500,000 shares of Series D Redeemable Convertible Preferred Stock
        (“Series D”) having a stated value of $10 per share, pursuant to a Securities
        Purchase Agreement with Laurus. The Company received $5,000,000 in gross
        proceeds, less a management and placement agent fee of approximately $90,000,
        and related transaction costs of approximately $27,000. The Company utilized
        the
        proceeds to repay the $3 million term note with Laurus signed on July 6,
        2005.
        The Series D has a dividend equal to the prime rate plus one percent (1%)
        (9.25%
        at June 30, 2007) and provides for redemption over a thirty-six month period
        pursuant to an amortization schedule. In conjunction with the Series D, the
        Company also issued to Laurus a warrant to purchase up to 50,000 shares of
        the
        Company’s common stock at a price equal to $10.20 per share. The fair value of
        the warrants, were valued using the Black Scholes model and the following
        assumptions: volatility of 80%, an expected life 5 years, and a risk free
        interest rate of 4.12%. Net cash proceeds from this financing were $1,883,000
        (which included repayments of $3,000,000 of principal related to the July
        6,
        2005 term note and $117,000 of issuance costs).
 
 On
        May 31, 2006, the Company amended
        the Series D and the Certificate of Vote of Directors Establishing a Class
        or
        Series of Stock. The terms of the amendment permit the Company to defer
        approximately $455,000 of cash payments, representing the January 2006, February
        2006 and March 2006 amortization payments, and to defer the October 2006
        amortization payment, should such payment be required in cash, to the mandatory
        redemption date of September 30, 2008. In consideration, the Company agreed
        to
        the conversion of the April 2006, May 2006, June 2006, July 2006, August
        2006
        and September 2006 amortization payments into 261,233 shares of common stock
        of
        the Company at a conversion price of $3.48 per share, representing a reduction
        in principal of approximately $909,000, and to reduce the Fixed Conversion
        Price
        of the remaining Series D stock from $6.80 per share to $4.15 per share.
        In
        addition, Laurus was granted a warrant to purchase 150,000 shares of the
        Company’s common stock at an exercise price of $4.26 per share. The warrants
        were valued at $375,000 using the Black Scholes model and the following
        assumptions: volatility of 79%, an expected life 5 years, and a risk free
        interest rate of 4.89%.
 
 
 64
 
 On
        December 28, 2006, Laurus consented
        to permit the Company to defer the December 2006, January 2007, February
        2007,
        March 2007, April 2007, May 2007, June 2007, July 2007, and August 2007
        redemptions to the end of the term. The monthly redemption of approximately
        $152,000 plus accrued dividends resumes on September 1, 2007.  Subject
        to certain conditions, it is at the Company’s option to pay this amount in cash
        or in common stock at a fixed conversion price of $4.15 per common share.
        This
        fixed conversion price is subject to reset should the Company declare a stock
        dividend or split, combine the outstanding common stock into a smaller number
        of
        shares, or issue, by reclassification of its common stock, any shares or
        other
        securities of the Company. The fixed conversion price shall be adjusted
        proportionately so that the holder of the Series D shall be entitled to receive
        the kind and number of shares or other securities of the Company which such
        Laurus would have owned or have been entitled to receive after the happening
        of
        any of the events described above, had such shares of Series D Preferred
        Stock
        been converted immediately prior to the happening of such event.
 
 The
        following table reflects the
        required redemption of the Series D before the effect of the accrued
        dividends:
 
 Year
                  ending June 30:
              
              Preferred
                  Stock
                Monthly
                Redemption
                  Schedule2008
              
              
              1,515,0002009
              
              
              2,424,000Total
              
              $
              3,939,000
 
 The
        following conditions must be met in
        order for the Company to be permitted to pay in common stock: (1) the shares
        must be issued pursuant to an effective registration statement, (2) the average
        closing market price of the common stock for the five trading days immediately
        preceding a payment date must exceed the fixed conversion price by 110% and
        no
        one day’s closing price may be less than the fixed conversion price, and (3) the
        conversion dollar value may not exceed the aggregate of the prior 22 trading
        days’ dollar volume. The dividend rate is subject to a 2% decrease for every 25%
        the average trading price for the five trading days prior to a repayment
        date
        exceeds the fixed conversion price, to a minimum of 0%. In addition, upon
        notifying the holder, the Company has the option of redeeming any outstanding
        shares of Series D with cash by paying 130% of the stated value plus accrued
        interest.
 
 As
        a condition of closing, the Company
        and each of its Subsidiaries granted a security interest in their respective
        assets as well as providing Laurus a right of first refusal on future financing
        arrangements during the term of the Agreement. In the event Laurus declines
        to
        exercise its right of first refusal, it agreed to enter into such documentation
        as shall be reasonably requested by the Company in order to subordinate its
        rights under the Series D to the subsequent financier. The registration rights
        associated with the Agreement state that the Company will use its best efforts
        to have the registration statement effective within 120 days from closing.
        In
        addition, the Company is required to maintain an effective registration
        statement, and ensure that shares are not suspended from trading. Upon notice
        from Laurus, should the Company be declared in default of these items and
        have
        not cured the default within the prescribed period, the Company may be assessed
        liquidated damages equal to 1/30th of 0.1%
        of the
        outstanding preferred balance, payable in cash, for each day the event has
        occurred and remains outstanding. However, pursuant to the Agreement,
“liquidated damages do not apply should the Securities and Exchange Commission
        (“SEC”) have an issue with respect to the Holder or with respect to the
        structure of the transaction.”
 
 In
        accordance with the provisions of
        Emerging Issues Task Force (“EITF”) Issue 00-19, “Accounting for Derivative
        Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own
        Stock,” the Company concluded that the Series D contained a conversion feature
        which should be valued at fair value and be recorded as a liability on the
        balance sheet. This conversion feature is not considered to be a “conventional
        preferred” instrument because the Agreement includes certain conditions under
        which the conversion price may be reset. This condition would suggest that
        the
        number of shares to be issued upon conversion is not fixed, which is a
        requirement of a “conventional preferred” instrument. This conversion feature
        was also determined to be a liability since it may be required to be repaid
        in
        cash, cannot be paid in unregistered shares and has certain penalties. These
        conditions define the conversion feature as an embedded derivative which
        must be
        separated from the host and reported at fair value pursuant to SFAS 133,
        “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No.
        133”).
 
 
 65
 
 The
        Series D also contains certain
        other embedded derivatives which, pursuant to SFAS No. 133, must be bifurcated
        from the host contract and reported at its fair market value. The first feature
        includes a dividend rate that is subject to adjustment based on the market
        price
        of the Company’s common stock. The second feature, related to potential default
        provisions, could potentially increase the dividend and redemption price,
        similar to a default or penalty clause in a debt-like instrument. Although
        the
        Company has valued all embedded derivatives of the host contract as one
        derivative instrument, the Company believes the value of the adjustable dividend
        rate and the potential default provisions features are immaterial. Management
        considered a number of factors, including independent appraisals when making
        this determination. The Company will continue to measure all derivatives
        at each
        reporting period as future changes in value may become material.
 
 The
        conversion feature aggregated to
        $1,397,000 on September 30, 2005 based on the Black- Scholes valuation model
        and
        the following assumptions: volatility 80%, expected life 1.5 years, and a
        risk
        free interest rate of 3.96%.  The conversion feature is marked to
        market at each reporting period with changes flowing through the statement
        of
        operations. As of June 30, 2007 and 2006, the fair value of this conversion
        feature approximated $133,000 and $1,094,000 respectively. The expected
        life of the conversion feature at June 30, 2007 was estimated to be 1.13
        years.  The value of the embedded derivates related to the
        adjustable dividend rate and the potential default provisions were determined
        to
        be immaterial at June 30, 2007.
 
 The
        Company valued the Series D at
        issuance at its residual value of $2,700,000 based on the fair values of
        the
        financial instruments issued in connection with this preferred stock financing,
        including the warrants, the embedded derivative instruments and offering
        costs.
        The amounts recorded in the financial statements represent the amounts
        attributed to the sale of the Series D preferred stock, the amount allocated
        to
        warrants of $672,000, the value attributed to the embedded derivatives of
        $1,397,000 and $271,000 of issuance costs (including $154,000 of unamortized
        costs of the July 6, 2005 term note). The Company is accreting these discounts
        on the carrying value of the preferred stock to its redemption value at
        September 1, 2008, or the actual conversion date, whichever is earlier. The
        accretion of these amounts is being recorded as a preferred dividend in the
        period of accretion. As of June 30, 2007 and 2006, $1,351,000 and $777,000
        was
        amortized and the outstanding balance on the Series D was $3,939,000 and
        $4,091,000, respectively.
 
 The
        amendment of the Series D, as
        described above, was accounted for as an extinguishment of debt in accordance
        with EITF 96-19 "Debtor's Accounting for a Modification or Exchange of Debt
        Instruments." The Company determined a substantial difference in the net
        present
        value of the cash flows under the terms of the amendment was more than 10
        percent different from the present value of the remaining cash flows under
        the
        terms of the original Series D agreement. Due to the substantial difference,
        the
        Company determined an extinguishment of debt had occurred with the amendment,
        and as such, it was necessary to reflect the Series D at its fair market
        value
        and record a loss on extinguishment of debt of approximately
        $1,294,000.
 
 Extinguishment
                  of Series D debt instrument at May 31, 2006:Redemption
                  payments
                  due
              
              $
              909,000Unamortized
                  discount of warrants, derivative value of preferred stock
                conversion
                  and issue costs
              
              
              266,000Derivatives
                  related to the preferred stock features
              
              
              578,000Subtotal
              
              $
              1,753,000Record
                  New Series D debt instrument at May 31, 2006:Fair
                  value of redemption payments made
              
              $
              1,011,000Issuance
                  of 150,000 warrants
              
              
              375,000Unamortized
                  discount of warrants, derivative value of preferred stock
                conversion
                  and issue costs
              
              
              266,000Derivatives
                  related to the preferred stock features
              
              
              1,395,000Subtotal
              
              $
              3,047,000Loss
                  on extinguishment of Series D debt instrument
              
              $
              1,294,000
  The
        $1,294,000 aggregate loss from
        these transactions was accounted for as an extinguishment of debt and is
        included in Other expenses for the year ended June 30, 2006.
 
 
 66
 
 **14.           Stockholders’
        Equity**
 
 (a)           IPO
        Units
 
 In
        June 1999, the Company issued
        1,138,000 Units, consisting of one share of common stock and one redeemable
        common stock purchase warrant (the “IPO Warrants”), in connection with its
        initial public offering.  Each Unit carries the right to purchase one
        share of common stock at $9.00, and is redeemable by the Company at $0.20
        per
        warrant if the closing bid price of the common stock averages in excess of
        $10.50 for a period of 20 consecutive trading days.  On April 15,
        2003, the Company extended the expiration date of the IPO warrants from June
        30,
        2003 to June 30, 2005.  The Company did not receive any consideration
        from the holders of the warrants; accordingly, the Company recognized the
        value
        of this transaction as a preferred distribution based upon the estimated
        fair
        value of the extension of approximately $195,000.  On March 14, 2005,
        the Company again extended the expiration date of the IPO warrants from June
        30,
        2005 to March 31, 2006.  The Company did not receive any consideration
        from the holders of the warrants; accordingly, the Company recognized the
        value
        of this transaction as a preferred distribution based upon the estimated
        fair
        value of the extension of approximately $479,000.  On March 31, 2006,
        the IPO warrants expired.  There are no IPO Warrants
        outstanding.
 
 (b)           Option
        Activity
 
 In
        September 1998, the Company adopted
        the 1998 Stock Option Plan (the “1998 Plan”). The 1998 Plan provides for the
        grant of incentive stock options and nonqualified stock options to employees
        and
        affiliates. The exercise price of the options equals 100% or 110% of the
        fair
        market value on the date of the grant. The exercise price of the options
        equal
        100% of the fair market value on the date of the grant or 110% of the fair
        market value for greater than 10% beneficial owners of the Company stock.
        Options expire between five and ten years from the date of the option grant
        and
        have various vesting periods. Options may be exercised by the Holder delivering
        to the Company cash in an amount equal to such aggregate exercise price,
        or with
        the consent of the Committee, shares of Company Common Stock having a fair
        market value equal to such aggregate exercise price, a personal recourse
        note
        issued to the Company in a principal amount equal to such aggregate exercise
        price or other acceptable consideration including a cashless exercise/resale
        procedure or any combination of the foregoing. The Committee may in its
        discretion provide upon the grant of any option that the Company shall have
        an
        option to repurchase, upon terms and conditions determined by the Committee,
        all
        or any number of shares purchased upon exercise of such option. A total of
        280,000 options were reserved for issuance under the 1998 Plan. Upon adoption
        of
        the 1998 Plan, the 1992 Stock Option Plan was terminated.
  In
        December 2000, the Company adopted
        the 2000 Incentive and Non Qualified Stock Option Plan (the “2000 Plan”). The
        2000 Plan provides for the grant of incentive stock options and nonqualified
        stock options to employees and affiliates. The exercise price of the options
        equal 100% of the fair market value on the date of the grant or 110% of the
        fair
        market value for greater than 5% beneficial owners of the Company stock.
        Options
        expire between five and ten years from the date of the option grant and have
        various vesting periods. Options may be exercised by the Holder delivering
        to
        the Company cash in an amount equal to such aggregate exercise price, or
        with
        the consent of the Committee, shares of Company Common Stock having a fair
        market value equal to such aggregate exercise price, a personal recourse
        note
        issued to the Company in a principal amount equal to such aggregate exercise
        price or other acceptable consideration including a cashless exercise/resale
        procedure or any combination of the foregoing. The Committee may in its
        discretion provide upon the grant of any option that the Company shall have
        an
        option to repurchase, upon terms and conditions determined by the Committee,
        all
        or any number of shares purchased upon exercise of such option. A total of
        600,000 options were originally reserved for issuance under the 2000 Plan.
        In
        December 2003, the stockholders of the Company approved an increase in the
        2000
        Incentive and Non-Qualified Stock Option Plan from 600,000 shares to 1,000,000
        shares. In December 2004, the stockholders of the Company approved an increase
        in the 2000 Incentive and Non-Qualified Stock Option Plan from 1,000,000
        shares
        to 1,500,000 shares.
 
 
 67
 
 In
        December 2004, the Company adopted
        the 2004 Stock Option Plan (the “2004 Plan”). The 2004 Plan provides for the
        grant of incentive stock options and nonqualified stock options to employees
        and
        affiliates. A total of 500,000 options were originally reserved for issuance
        under the 2000 Plan. The exercise price of the options equa1 100% of the
        fair
        market value on the date of the grant or 110% of the fair market value for
        greater than 10% beneficial owners of the Company stock. Options expire between
        five and ten years from the date of the option grant and have various vesting
        periods. At the December 2005 annual meeting the shareholders voted to increase
        the shares available for issuance under the 2004 Plan by 500,000 to 1,000,000
        shares. Options may be exercised by the Holder delivering to the Company
        cash in
        an amount equal to such aggregate exercise price, or with the consent of
        the
        Committee, shares of Company Common Stock having a fair market value equal
        to
        such aggregate exercise price, a personal recourse note issued to the Company
        in
        a principal amount equal to such aggregate exercise price or other acceptable
        consideration including a cashless exercise/resale procedure or any combination
        of the foregoing. In December 2005, the stockholders of the Company approved
        an
        increase in the 2004 Incentive and Non-Qualified Stock Option Plan from by
        500,000 shares to 1,000,000 shares.
  As
        of June 30, 2007, a total of
        137,003, 245,602, and 278,000 shares are available for issuance under the
        1998,
        2000 and 2004 Plans, respectively.
 
 The
        following table presents the
        activity of the 1992, 1998, 2000 and 2004 Stock Option Plans for the years
        ended
        June 30, 2007, 2006 and 2005:
  **2007**
              
              
              **2006**
              
              
              **2005****Shares**
              
              
              **Weighted-**
                **Average**
                **Exercise**
                **Price**
              
              
              **Shares**
              
              
              **Weighted-**
                **Average**
                **Exercise**
                **Price**
              
              
              **Shares**
              
              
              **Weighted-**
                **Average**
                **Exercise**
                **Price**Outstanding
                  at beginning of period
              
              
              1,836,551
              
              
              $
              5.41
              
              
              
              1,908,331
              
              
              $
              5.66
              
              
              
              1,162,065
              
              
              $
              5.55Granted
              
              
              540,188
              
              
              
              2.16
              
              
              
              557,750
              
              
              
              4.43
              
              
              
              973,726
              
              
              
              5.91Exercised
              
              
              (34,365
              )
              
              
              1.49
              
              
              
              (41,700
              )
              
              
              3.46
              
              
              
              (153,160
              )
              
              
              5.69Canceled
              
              
              (551,636
              )
              
              
              4.90
              
              
              
              (587,830
              )
              
              
              6.62
              
              
              
              (74,300
              )
              
              
              8.74Outstanding
                  at end of period
              
              
              1,790,738
              
              
              
              4.66
              
              
              
              1,836,551
              
              
              
              5.41
              
              
              
              1,908,331
              
              
              
              5.66Options
                  exercisable at end of period
              
              
              1,180,708
              
              
              
              5.32
              
              
              
              1,113,947
              
              
              
              4.98
              
              
              
              1,016,362
              
              
              
              4.51Weighted-average
                  fair value of options granted during the year
              
              
              
              
              
              $
              1.37
              
              
              
              
              
              
              $
              2.72
              
              
              
              
              
              
              $
              4.37
 
 
 The
        following table presents weighted average price and life information about
        significant options groups outstanding at June 30, 2007:
 
 **Options
                      Outstanding**
                  
                  
                  **Options
                      Exercisable**Range
                      of Exercise Prices
                  
                  Number
                      of Shares
                  
                  
                  Weighted
                      Average Remaining Contractual Life (in years)
                  
                  
                  Weighted
                      Average Exercise Price
                  
                  
                  Intrinsic
                      Value per Share
                  
                  
                  Number
                      of Shares
                  
                  
                  Weighted
                      Average Exercise Price
                  
                  
                  Intrinsic
                      Value per Share$1.64
                      - $2.89
                  
                  
                  454,188
                  
                  
                  
                  7.07
                  
                  
                  $
                  2.06
                  
                  
                  $
                  (0.42
                  )
                  
                  
                  64,188
                  
                  
                  $
                  2.24
                  
                  
                  $
                  (0.60
                  )$3.07
                      - $4.65
                  
                  
                  801,550
                  
                  
                  
                  5.64
                  
                  
                  $
                  4.00
                  
                  
                  $
                  (0.42
                  )
                  
                  
                  682,170
                  
                  
                  $
                  4.08
                  
                  
                  $
                  (2.44
                  )$5.25
                      - $7.56
                  
                  
                  315,000
                  
                  
                  
                  5.52
                  
                  
                  $
                  6.51
                  
                  
                  $
                  (4.87
                  )
                  
                  
                  272,100
                  
                  
                  $
                  6.50
                  
                  
                  $
                  (4.86
                  )$9.15
                      - $10.90
                  
                  
                  220,000
                  
                  
                  
                  7.12
                  
                  
                  $
                  9.76
                  
                  
                  $
                  (8.12
                  )
                  
                  
                  162,250
                  
                  
                  $
                  9.80
                  
                  
                  $
                  (8.16
                  )1,790,738
                  
                  
                  
                  
                  
                  
                  $
                  4.66
                  
                  
                  $
                  (3.02
                  )
                  
                  
                  1,180,708
                  
                  
                  $
                  5.32
                  
                  
                  $
                  (3.68
                  )
  The
          intrinsic value of options exercised during fiscal 2007, 2006 and 2005
          was
          approximately $28,000, $103,000 and $558,000 respectively.
 
 **Year
                  ending June 30:**2008
              
              $
              421,0002009
              
              
              211,0002010
              
              
              94,000Total
              
              $
              726,000
 
 
 68
 
 *(c)        
        Employee Stock Purchase Plan*
 
 In
        September 1998, the Company adopted
        the 1998 Employee Stock Purchase Plan (the “Plan”). The Plan provides a method
        whereby employees of the Company will have an opportunity to acquire an
        ownership interest in the Company through the purchase of shares of common
        stock
        of the Company through payroll deductions. After 12 months of employment,
        an
        employee is eligible to participate and can defer up to 10% of their wages
        into
        this Plan, with a maximum of $25,000 in any calendar year. The purchase price
        of
        the common stock is calculated at the lower of 85% of the closing price of
        the
        stock on the first day of the plan period or the last day of the plan period.
        The periods are January 1 to June 30 and July 1 to December 31. Fractional
        shares are not issued. Participants may withdraw at any time by giving written
        notice to the Company and will be credited the amounts of deferrals in their
        account. The maximum number of shares eligible to be issued under the Plan
        is
        141,000. As of June 30, 2007, a total of 10,669 shares are available for
        issuance under the Plan.
 
 In
        December 2006, the Company adopted
        the 2006 Employee Stock Purchase Plan (the “2006 Plan”). The 2006 Plan provides
        a method whereby employees of the Company will have an opportunity to acquire
        an
        ownership interest in the Company through the purchase of shares of common
        stock
        of the Company through payroll deductions. After 12 months of employment,
        an
        employee is eligible to participate and can defer up to 10% of their wages
        into
        this Plan, with a maximum of $25,000 in any calendar year. The purchase price
        of
        the common stock is calculated at the lower of 85% of the closing price of
        the
        stock on the first day of the plan period or the last day of the plan period.
        The periods are January 1 to June 30 and July 1 to December 31. Fractional
        shares are not issued. Participants may withdraw at any time by giving written
        notice to the Company and will be credited the amounts of deferrals in their
        account. The maximum number of shares eligible to be issued under the 2006
        Plan
        is 500,000. As of June 30, 2007, a total of 481,023 shares are available
        for
        issuance under the 2006 Plan.
 
 *(d)           Warrants
        and non-qualified options*
 
 In
        October 2004, the Company issued
        200,000 common stock warrants, at an exercise price of $9.75, to a consultant
        in
        connection with the Core acquisition. The warrants were fully vested upon
        issuance and expire 5 years from the date of grant. The Company recorded
        the
        fair value of these warrants, of approximately $1,122,000, as additional
        costs
        associated with the Core acquisition and included this value in the total
        purchase price of the acquisition.
  In
        March 2005, in connection with a
        private placement, the Company issued warrants to the investors to purchase
        270,195 shares of common stock, and warrants to placement agents to purchase
        43,231 shares of common stock, at an exercise price of $9.35, which are
        exercisable anytime between September 4, 2005 and September 4,
        2010.
 
 In
        July 2005, in connection with the a
        short term note with Laurus Master Fund, the Company issued warrants to the
        investor to purchase up to 250,000 shares of common stock at an exercise
        price
        of $3.75, which are exercisable anytime between September 30, 2005 and September
        30, 2010.
 
 In
        September 2005, in conjunction with
        the Series D financing, the Company issued warrants to the investors to purchase
        50,000 shares of common stock at an exercise price of $10.20, which are
        exercisable anytime between September 30, 2005 and September 20,
        2010.
  In
        April 2006, in connection with an
        agreement with two investors, the Company issued warrants to purchase a total
        of
        35,000 shares of common stock at an exercise price of $3.75 per share, which
        are
        exercisable between April 17, 2006 and July 6, 2010. The Company recorded
        the
        fair value of these warrants, of approximately $67,000, as an operating expense
        in the accompanying statement of operations during the year ended June 30,
        2006.
 
 In
        May 2006, in conjunction with a
        modification to the Series D financing, the Company issued warrants to purchase
        150,000 shares of common stock at an exercise price of $4.26 per share. The
        warrants are exercisable between May 31, 2006 and May 31, 2011. The Company
        recorded the fair value of these warrants of approximately $375,000 as a
        conversion expense in the accompanying statement of operations during the
        year
        ended June 30, 2006.
 
 69
 
 During
        the year ended June 30, 2006,
        the Company issued fully vested warrants to various advisors in exchange
        for
        services, to purchase a total of 27,500 shares of common stock at exercise
        prices ranging from $3.40 to $4.14. The Company recorded the fair value of
        these
        warrants of approximately $52,000 as stock based compensation expense. In
        addition, approximately $26,000 of additional compensation expense was recorded
        relating to certain warrants issued in prior years being expensed over their
        vesting period.
 
 In
        December 2006, in conjunction with a
        short term note, the Company issued warrants to purchase 458,000 shares of
        common stock at an exercise price of $2.50 per share. The warrants are
        exercisable between December 29, 2006 and December 29, 2011. The Company
        recorded the relative fair value of these warrants of approximately $450,000
        and
        is accreting their valueto the term note over
        the life of the
        noteas an interest
        expensein
        the accompanying statement of
        operations.
 
 In
        January 2007, inconjunction with a term note, the Company issued warrants to purchase
        18,939 shares of common stock at an exercise price of $2.64 per share. The
        warrants are exercisable between January 2, 2007 and January 2, 2014. The
        Company recorded the relative fair value of these warrants of approximately
        $28,000 and is accreting their value to the term note over the life of the
        note
        as an interest expense in the accompanying statement of operations during
        the
        year ended June 30, 2007.
 
 In
        May 2007, in conjunction with the
        sale of the assets of Accurel, the Company issued warrants to various advisors
        to purchase 375,000 shares of common stock at an exercise price of $2.00
        per
        share. The warrants are exercisable between May 1, 2007 and May 1, 2012.
        The
        Company recorded the fair value of these warrants of approximately $389,000
        as
        part of the loss on sale of assets in the accompanying statement of operations
        during the year ended June 30, 2007.
 
 During
        the year ended June 30, 2007,
        the Company issued fully vested warrants to various advisors in exchange
        for
        services, to purchase a total of 80,000 shares of common stock at exercise
        prices ranging from $2.32 to $2.82. The Company recorded the fair value of
        these
        warrants of approximately $136,000 as stock based compensation expense. In
        addition, approximately $5,000 of additional compensation expense was recorded
        relating to certain warrants and non-qualified stock options issued in prior
        years being expensed over their vesting period.
 
 The
        Company estimated the fair value of
        the warrants issued during 2007, 2006 and 2005 using the Black-Scholes
        option-pricing model. The Company estimated the fair value of the warrants
        using
        the following input assumptions:
 
 **2007**
              **2006**
              **2005**Volatility
              76.1%
                  - 78.6%
              78.5%
                  - 80.4%
              62.0%
                  - 65.0%Dividend
                  yield
              0%
              0%
              0%Risk-free
                  interest rate
              4.53%
                  - 5.07%
              3.86%
                  - 4.89%
              3.47%
                  - 4.17%Expected
                  lives
              2
                  -
                  7 years
              2.5
                  - 5 years
              1
                  -
                  5 years
 
 The
        following table presents the weighted average exercise price of warrants
        outstanding at June 30, 2007:
 
 **Warrants
                    Outstanding and Exercisable****Range
                    of Exercise Prices**
                
                **Number
                    of Warrnt Shares**
                
                
                **Weighted
                    Average Exercise Price**
                
                
                **Weighterd
                    Average Intrinsic Value /Share**$2.00
                    - $5.24
                
                
                1,591,841
                
                
                $
                2.99
                
                
                $
                (1.35
                )$6.23
                    - $9.95
                
                
                698,426
                
                
                
                8.62
                
                
                
                (6.98
                )$10.13
                    - $14.00
                
                
                303,000
                
                
                
                12.22
                
                
                
                (10.58
                )2,593,267
                
                
                $
                5.58
                
                
                $
                (3.94
                )
 
 70
 
 The
        following table presents the
        warrant activity for the years ended June 30, 2007, 2006 and
        2005:
  **2007**
              
              
              **2006**
              
              
              **2005****Shares**
              
              
              **Weighted
                  Average Exercise Price**
              
              
              **Shares**
              
              
              **Weighted
                  Average Exercise Price**
              
              
              **Shares**
              
              
              **Weighted average**
                **Exercise
                  Price**Outstanding
                  at beginning of period
              
              
              1,756,003
              
              
              $
              7.64
              
              
              
              2,324,389
              
              
              $
              9.53
              
              
              
              1,876,803
              
              
              $
              9.72Granted
              
              
              931,939
              
              
              
              2.31
              
              
              
              512,500
              
              
              
              4.53
              
              
              
              559,426
              
              
              
              9.01Exercised
              
              
              -
              
              
              
              -
              
              
              
              (16,186
              )
              
              
              4.32
              
              
              
              (42,810
              )
              
              
              3.28Canceled
              
              
              (94,675
              )
              
              
              12.00
              
              
              
              (1,064,700
              )
              
              
              9.00
              
              
              
              (69,030
              )
              
              
              14.40Warrants
                  Outstanding at end of period
              
              
              2,593,267
              
              
              $
              5.60
              
              
              
              1,756,003
              
              
              $
              7.67
              
              
              
              2,324,389
              
              
              $
              9.53Warrants
                  exercisable at end of period
              
              
              2,485,677
              
              
              $
              5.59
              
              
              
              1,740,669
              
              
              $
              7.64
              
              
              
              2,293,389
              
              
              $
              9.01Weighted-average
                  fair value of warrants granted during the year
              
              
              
              
              
              $
              1.27
              
              
              
              
              
              
              $
              4.53
              
              
              
              
              
              
              $
              9.01
 
 
 **15.          
        401k Plan**
  The
        Company has a defined contribution
        retirement plan which contains a 401(k) plan. All employees who meet the
        age
        requirement, either 18 or 21, and who have completed the minimum service
        requirement are eligible for participation in the plan. The Company may make
        discretionary contributions to the 401(k) plan. During the years ended June
        30,
        2007, 2006 and 2005, the Company made no contributions to the plan.
  **16.         
        Long-term
        Debt**
  *MED-TEC
        Payment Obligation*
 
 On
        July 31, 2003, the Company entered
        into an agreement with its former exclusive distributor of prostate seeds,
        to
        release each other from further obligations under the original Distributor
        Agreement.  The new agreement conveys to the Company direct marketing and
        sales capabilities to sell its I-Plant Seed brachytherapy seeds for use in
        the
        treatment of prostate cancer.  In connection with this, the Company’s
        former exclusive distributor agreed to work cooperatively to transition
        customers and marketing materials directly to the Company.  The distributor
        also agreed not to compete with the Company for a period of three years. 
The present value of this payment obligation was recorded as approximately
        $1,007,000, using a rate of 10.24%. This amount was recorded as an intangible
        asset and is being amortized over its estimated useful life of 29 months. 
During the years ended June 30, 2007, 2006, and 2005, approximately $0, $417,000
        and $383,000, respectively, of amortization expense was recognized, which
        is
        included in selling, general and administrative expenses in the accompanying
        consolidated statements of operations.  The outstanding and past due
        principal balance as of June 30, 2007 and June 30, 2006 was approximately
        $143,000, and $233,000 respectively.  Also included in accrued expenses
        were $64,000 and $42,000 of accrued interest as of June 30, 2007 and 2006
        respectively.  For the years ended June 30, 2007, 2006 and 2005, the
        Company recorded approximately $23,000, $30,000, and $46,000, respectively,
        of
        interest expense relating to this transaction.
  *Installment
        Note - Accurel*
 
 At
        the time of its acquisition, Accurel
        had a $1,400,000 fixed rate installment note with a bank. The note called
        for
        monthly payments of $29,000 plus interest at a rate of 6.84%, through September
        1, 2008 (the “Loan Agreement”).  The bank consented to continue the
        note under the same terms after the acquisition.  The note is
        collateralized by substantially all assets of Accurel. During the years ended
        June 30, 2007, 2006 and 2005, the Company recorded interest expense of
        approximately $29,000, $71,000 and $25,000, respectively, in connection with
        this note.  As of June 30, 2007, the Accurel note was paid in
        full.
 
 
 71
 
 *Revolving
        Credit Facility and Term Note with Bridge Bank*
 
 On
        June 8, 2005, the Company executed a
        revolving credit facility for $1,500,000 with Silicon Valley based Bridge
        Bank,
        N.A. The revolving credit facility provides for advances of up to eighty
        percent
        (80%) of the Company’s eligible accounts receivable, bears interest at the prime
        rate plus one-half percent (1/2%) which is subject to a one-half percent
        (1/2%)
        increase should minimum cash balances not be maintained. The revolving credit
        facility is collateralized by certain assets of the Company and is subject
        to
        certain covenants.  The balance on the revolving credit facility as of
        June 30, 2006 was $1,000,000.
 
 On
        January 3, 2007, the Company executed an Amended and Restated Loan and Security
        Agreement (the “Loan Agreement”) which amended and restated the terms of a
        Business Financing Agreement originally dated as of June 1, 2005 with Silicon
        Valley based Bridge Bank, N.A. (the “Bank”) increasing the revolving credit
        facility from $1.5 million to $5.0 million.  This revolving credit
        facility (the “line of credit”) has a two year term, provides for advances of up
        to eighty percent (80%) of the Company’s eligible accounts receivable and up to
        the lesser of $1,000,000 or forty percent (40%) of eligible inventory, bears
        interest at the prime rate, plus one-half percent (1/2%) per annum, and is
        collateralized by all assets of the Company.  In addition, the
        expiration date of the facility was extended to December 21, 2008.
 
 On
        April 27, 2007, in conjunction with
        the sale of the assets of Accurel, the Company entered into a Loan and Security
        Modification Agreement whereby the Bank consented to the sale of the Accurel
        assets and removed Accurel as a borrower under the Loan Agreement.
 
 On
        May 16, 2007, the Company entered
        into a Loan and Security Modification Agreement whereby the Bank added Accurel
        and its remaining assets as a borrower under the Loan Agreement.
 
 On
        June 29, 2007, in conjunction with
        the sale of certain of the assets of the Company’s brachytherapy business, the
        Company entered into a Loan and Security Modification Agreement whereby the
        Bank
        consented to the sale of these assets.
 
 In
        conjunction with this financing, the Company drew from funds available on
        the
        line of credit and paid in full an outstanding term loan balance of
        approximately $623,000 at Comerica Bank.  In addition, pursuant to the
        terms of the Loan Agreement, the Company converted $1,600,000 of the outstanding
        line of credit balance into a 30 month term note bearing an interest rate
        at the
        prime rate plus one percent (1%) per annum payable in thirty (30) equal monthly
        installments of principal, plus all accrued interest beginning on February
        10,
        2007.
  Pursuant
        to the Loan Agreement, the Company issued to Bridge Bank. N.A. a seven-year
        warrant to purchase up to 18,939 shares of the Company’s common stock at a price
        equal to $2.64 per share.  The warrants were valued using the Black
        Scholes model and the following assumptions: volatility of 78%, an expected
        life
        7 years, and a risk free interest rate of 4.54%.  Pursuant to ABP No
        14 “Accounting for Convertible Debt and Debt Issued with Stock Purchase
        Warrants”, the note and warrants have been recorded at their relative fair
        value.  The Company will accrete the value of the warrants, $28,000,
        to the term note over the life of the note.   As of June 30,
        2007, approximately $6,000 has been amortized.
 
 The
        Company was in violation of certain covenants associated with this facility
        at
        June 30, 2007, and has received waivers from the bank.  As of June 30,
        2007 and 2006, this revolving credit facility had a zero balance.  As
        of June 30, 2007 and 2006, the term note had a balance of $1,299,000 and
        $0,
        respectively.
 
 *Laurus
        Short Term Note*
 
 On
        December 29, 2006, the Company executed a $1.5 million secured term note
        (the
“Note”) payable to Laurus.   The Company received $1,500,000 in
        gross proceeds, less a management fee of $60,000 and related transaction
        costs
        of approximately $500.  The term note is collateralized by
        substantially all of the Company’s assets and two of its subsidiaries, has a
        9-month term and bears interest at a rate equal to prime plus 1% per annum.
        The
        Note contains certain restrictive and financial covenants. Upon the occurrence
        of certain events of default specified in the Note, amounts owed under the
        Note
        may be declared immediately due and payable. In connection with the financing,
        the Company issued Laurus a warrant to purchase up to 458,000 shares of the
        Company’s common stock at a price equal to $2.50 per share.  The
        warrants were valued using the Black Scholes model and the following
        assumptions: volatility of 78%, an expected life of 5 years, and a risk free
        interest rate of 4.53%. Net cash proceeds from this financing were $1,439,500
        and were used for general working capital.
 
 
 72
 
 Pursuant
        to ABP No 14 “Accounting for
        Convertible Debt and Debt Issued with Stock Purchase Warrants”, the note and
        warrants have been recorded at their relative fair value.  The Company
        accreted the value of the warrants, to interest expense, $450,000, to the
        term
        note over the life of the note.  As of June 30, 2007, the warrants
        have been fully accreted to interest expense and the loan has been paid in
        full.
 
 **17.           Financial
        Information by Segment**
 
 Under
        SFAS No. 131, “Disclosures about
        Segments of an Enterprise and Related Information,” operating segments are
        defined as components of an enterprise about which separate financial
        information is available that is evaluated regularly by the chief operating
        decision maker, or decision making group, in deciding how to allocate resources
        and in assessing performance. The Company's chief operating decision making
        group is composed of the chief executive officer and members of senior
        management. The Company's reportable segments are: Medical, Semiconductor
        and
        Security Products.
 
 Gross
        margin is the measure that
        management uses when evaluating the Company’s segments, therefore, operating
        expenses are excluded from the financial information below.
 
 The
        revenues, expenses and
        assets related to these segments for the years ended June 30, 2007, 2006
        and 2005 are:
 
 **Medical**
              
              
              **Semiconductor**
              
              
              **Security**
              
              
              **Total****Year
                  Ended June 30, 2007**Revenue
              
              $
              3,976,000
              
              
              $
              6,874,000
              
              
              $
              4,582,000
              
              
              $
              15,432,000Cost
                  of revenues
              
              
              (3,717,000
              )
              
              
              (6,406,000
              )
              
              
              (3,332,000
              )
              
              
              (13,455,000
              )Gross
                  margin
              
              $
              259,000
              
              
              $
              468,000
              
              
              $
              1,250,000
              
              
              $
              1,977,000Total
                  assets
              
              $
              3,166,000
              
              
              $
              13,502,000
              
              
              $
              2,932,000
              
              
              $
              19,600,000**Year
                  Ended June 30, 2006**Revenue
              
              $
              4,464,000
              
              
              $
              6,739,000
              
              
              $
              6,871,000
              
              
              $
              18,074,000Cost
                  of revenues
              
              
              (3,869,000
              )
              
              
              (6,364,000
              )
              
              
              (6,222,000
              )
              
              
              (16,455,000
              )Gross
                  margin
              
              $
              595,000
              
              
              $
              375,000
              
              
              $
              649,000
              
              
              $
              1,619,000Total
                  assets
              
              $
              3,822,000
              
              
              $
              24,312,000
              
              
              $
              2,665,000
              
              
              $
              30,779,000**Medical**
              
              
              **Semiconductor**
              
              
              **Security**
              
              
              **Total****Year
                  Ended June 30, 2005**Revenue
              
              $
              4
                  ,146,000
              
              
              $
              4,356,000
              
              
              $
              1,510,000
              
              
              $
              10,012,000Cost
                  of revenues
              
              
              (3,821,000
              )
              
              
              (4,797,000
              )
              
              
              (1,919,000
              )
              
              
              (10,537,000
              )Gross
                  margin
              
              $
              325,000
              
              
              $
              (441,000
              )
              
              $
              (409,000
              )
              
              $
              (525,000
              )Total
                  assets
              
              $
              5,227,000
              
              
              $
              25,492,000
              
              
              $
              1,509,000
              
              
              $
              32,228,000
 
 
 During
        the fiscal year ended June 30,
        2007, foreign sales represented 31% of total revenue.  For the fiscal
        year ended June 30, 2006, foreign sales represented 26% of revenue with one
        customer from China representing 17% of the Company’s annual
        revenues.  For fiscal year ended June 30, 2005, foreign sales
        represented less than 10% of total revenue.
 
 73
 
 **18.           Goodwill,
        Other Intangible and Long-Lived Assets**
  At
        June****30, 2007,
        2006 and 2005, the Company had goodwill of $2,062,000, $4,091,000 and
        $4,641,000, respectively. SFAS No. 142, “Goodwill and Other Intangible Assets”,
        requires that goodwill and intangible assets with indefinite lives no longer
        be
        amortized but instead be measured for impairment at least annually or whenever
        events indicate that there may be an impairment. In order to determine if
        impairment exists, management continually estimates the reporting unit’s fair
        value based on market conditions and operational performance. The Company
        may
        employ the work of independent appraisers in making its determination. The
        Company makes its annual assessment as of August 31st of each year to determine
        if its goodwill is impaired. At June 30, 2006, the Company determined that
        its
        goodwill in its semiconductor services reporting unit was impaired. As a
        result
        of these impairments, the Company took an impairment charge of $457,000,
        in the
        year ended June 30, 2006.
  Intangible
        assets with finite lives are
        valued according to the future cash flows they are estimated to produce.
        These
        assigned values are amortized over the period of time those cash flows are
        estimated to be produced. Management continually evaluates whether events
        or
        circumstances have occurred that indicate that the estimated remaining useful
        life or the carrying value of these assets has been impaired.
 
 SFAS
        No. 144, “Accounting for the
        Impairment or
        Disposal of Long-Lived Assets,” requires that long lived assets and/or asset
        groups shall be tested for recoverability whenever events or changes in
        circumstances indicate that its carrying amount may not be recoverable due
        to
        certain events or changes in circumstances.  When management measured
        the semiconductor processing reporting unit, it concluded that an impairment
        existed at June 30, 2007 and recorded an adjustment of
        $3,829,000.This impairment charge
        was allocated to
        the fixed and intangible assets and the goodwill in the following amounts,
        respectively:  $1,723,000, $77,000 and $2,029,000,
        respectively.
 
 Changes
        in the carrying value of
        goodwill for the years ended June 30, 2007 and 2006, by reportable segment,
        are
        as follows:
  **Semiconductor
                  Services**Balance
                  as of June 30, 2005
              
              $
              4,647,000Adjustments
                  to purchase price
              
              
              (99,000
              )Impairment
              
              
              (457,000
              )Balance
                  as of June 30, 2006
              
              
              4,091,000Impairment
              
              
              (2,029,000
              )Balance
                  as of June 30, 2007
              
              $
              2,062,000
 
 
 The
        following table summarizes the Company’s intangible assets as of June 30, 2007
        and 2006:
 
 **Gross
                  carrying amount**
              
              
              **Accumulated
                  Amortization**
              
              
              **Net
                  Carrying Amount****June
                  30, 2006**
              
              
              **Additions/
                  reductions**
              
              
              **June
                  30, 2007**
              
              
              **June
                  30, 2006**
              
              
              **Additions/reductions**
              
              
              **June
                  30, 2007**
              
              
              **June
                  30, 2007**Non-Compete
              
              $
              1,007,000
              
              
              $
              -
              
              
              $
              1,007,000
              
              
              $
              1,007,000
              
              
              $
              -
              
              
              $
              1,007,000
              
              
              $
              -Customer
                  Base
              
              
              210,000
              
              
              
              (49,000
              )
              
              
              161,000
              
              
              
              72,000
              
              
              
              41,000
              
              
              
              113,000
              
              
              
              48,000Technology
              
              
              125,000
              
              
              
              (28,000
              )
              
              
              97,000
              
              
              
              43,000
              
              
              
              25,000
              
              
              
              68,000
              
              
              
              29,000Treatment
                  Planning System
              
              
              300,000
              
              
              
              (300,000
              )
              
              
              -
              
              
              
              116,000
              
              
              
              (116,000
              )
              
              
              -
              
              
              
              -Total
              
              $
              1,642,000
              
              
              $
              (377,000
              )
              
              $
              1,265,000
              
              
              $
              1,238,000
              
              
              $
              (50,000
              )
              
              $
              1,188,000
              
              
              $
              77,000
 
 
 74
 
 
 **Gross
                  carrying amount**
              
              
              **Accumulated
                  Amortization**
              
              
              **Net
                  Carrying Amount****June
                  30, 2005**
              
              
              **Additions**
              
              
              **June
                  30, 2006**
              
              
              **June
                  30, 2005**
              
              
              **Additions**
              
              
              **June
                  30, 2006**
              
              
              **June
                  30, 2006**Non-Compete
              
              $
              1,007,000
              
              
              $
              -
              
              
              $
              1,007,000
              
              
              $
              799,000
              
              
              $
              208,000
              
              
              $
              1,007,000
              
              
              $
              -Customer
                  Base
              
              
              210,000
              
              
              
              -
              
              
              
              210,000
              
              
              
              30,000
              
              
              
              42,000
              
              
              
              72,000
              
              
              
              138,000Technology
              
              
              125,000
              
              
              
              -
              
              
              
              125,000
              
              
              
              18,000
              
              
              
              25,000
              
              
              
              43,000
              
              
              
              82,000Treatment
                  Planning System
              
              
              300,000
              
              
              
              -
              
              
              
              300,000
              
              
              
              16,000
              
              
              
              100,000
              
              
              
              116,000
              
              
              
              184,000Total
              
              $
              1,642,000
              
              
              $
              -
              
              
              $
              1,642,000
              
              
              $
              863,000
              
              
              $
              375,000
              
              
              $
              1,238,000
              
              
              $
              404,000
 
 Estimated
        amortization expense for intangible assets with finite lives on our balance
        sheet as of June 30, 2007, for the fiscal years ending June 30, is as
        follows:
 
 2008
              
              $
              33,0002009
              
              
              33,0002010
              
              
              11,000$
              77,000
 **19.           Treasury
        Stock**
  In
        June 2004, the Board authorized the
        Company to repurchase up to 300,000 shares of the Company’s common stock, from
        time to time in the open market, privately negotiated transactions, block
        transactions or at time and prices deemed appropriate by management. During
        July
        2004, the Company repurchased 6,000 shares of common stock at prices ranging
        from $8.91 to $9.02 per share with an average cost per share of $8.97 and
        a
        total cost of approximately $54,000, which is recorded as treasury stock
        in the
        accompanying consolidated balance sheet. As of June 30, 2007 and June 30,
        2006,
        the maximum number of shares authorized to be repurchased were
        294,000.
  In
        March 2004, the Company entered into
        an Exchange & Venture Agreement with CardioTech International and CorNova
        and issued 10,344 shares of common stock bearing an aggregate fair market
        value
        of $113,000. In February 2005, the Company issued an additional 76,687 shares
        of
        common stock bearing an aggregate fair market value of $750,000. In the quarter
        ended March 31, 2007, CorNova sold its holding of the Company’s
        stock.  As a result, 16,449 shares of stock previously categorized as
        treasury stock has been reclassified to additional paid in capital in the
        accompanying balance sheet.
 
 In January 2006, as the result of a cashless exercise of an Incentive Stock
        Option, the Company acquired 4,545 shares of common stock having a fair value
        of
        approximately $19,000.
  **20.           Rosses
        Medical**
  On
        May 6, 2005, the Company purchased
        certain software technology assets from Rosses Medical Systems for an aggregate
        purchase price of $300,000, consisting of $100,000 in cash and 43,197 shares
        of
        the Company’s common stock with a fair value of $200,000. In conjunction with
        this asset acquisition, the Company entered into consulting agreements with
        the
        former owners and a former employee of Rosses Medical and granted 181,426
        non-qualified stock options. These options are fully vested, have no exercise
        price and are exercisable upon achieving certain sales milestones, commencing
        November 6, 2005. The value of these options will be recorded as additional
        purchase price in the period earned. Should all sales milestones be achieved,
        the Company has estimated the fair value of these options using the Black
        Scholes option pricing model to be $796,000. As of June 30, 2007, all of
        the
        options have been forfeited as the sales goal targets have not been achieved.
        On
        June 29, 2007, this asset, which had an unamortized balance of $83,000, was
        sold
        as part of an asset sale.  The proceeds from this sale of $350,000
        were reduced by transaction costs of $45,000, unamortized assets of $203,000,
        along with assumed liabilities of $16,000, resulting in a gain of
        $118,000.
  75
  **ITEM
                  9.**
              **CHANGES
                  IN AND DISAGREEMENTS WITH
                  ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                  DISCLOSURE**
 
 Not
        applicable
 
 **ITEM
        9A.               CONTROLS AND
        PROCEDURES**
 
 EVALUATION
        OF OUR DISCLOSURE CONTROLS AND INTERNAL CONTROLS
  As
        of the end of the period covered by
        this annual report, we evaluated the effectiveness of the design and operation
        of our disclosure controls and procedures ("Disclosure Controls") and our
        internal controls and procedures for financial reporting ("Internal Controls").
        This evaluation (the "Controls Evaluation") was done under the supervision
        and
        with the participation of our management, including our Chief Executive Officer
        ("CEO") and Chief Financial Officer ("CFO"). Rules adopted by the SEC require
        that in this section of the Annual Report, we present the conclusions of
        our CEO
        and the CFO about the effectiveness of our Disclosure Controls and Internal
        Controls based on and as of the date of the Controls Evaluation.
 
 CEO
        AND
        CFO CERTIFICATIONS
  Appearing
        as exhibits to this Annual
        Report are "Certifications" of the CEO and the CFO. The Certifications are
        required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (the "Section
        302 Certifications"). This section of the Annual Report contains information
        concerning the Controls Evaluation referred to in the Section 302 Certifications
        and this information should be read in conjunction with the Section 302
        Certifications for a more complete understanding of the topics
        presented.
 
 DISCLOSURE
        CONTROLS AND INTERNAL CONTROLS
  Disclosure
        Controls are procedures that
        are designed with the objective of ensuring that information required to
        be
        disclosed in our reports filed under the Securities Exchange Act of 1934
        ("Exchange Act"), such as this Annual Report, is recorded, processed, summarized
        and reported within the time periods specified in the SEC's rules and forms.
        Disclosure Controls are also designed with the objective of ensuring that
        such
        information is accumulated and communicated to our management, including
        the CEO
        and CFO, as appropriate, to allow timely decisions regarding required
        disclosure. Internal Controls are procedures which are designed with the
        objective of providing reasonable assurance that (1) our transactions are
        properly authorized, recorded and reported; and (2) our assets are safeguarded
        against unauthorized or improper use, to permit the preparation of our financial
        statements in conformity with generally accepted accounting
        principles.
 
 LIMITATIONS
        ON THE EFFECTIVENESS OF CONTROLS
  Our
        management, including the CEO and
        CFO, has concluded that our disclosure controls and procedures are designed
        to
        provide reasonable assurance of achieving their objectives and have concluded
        that the controls and procedures are effective at that reasonable assurance
        level.
 
 SCOPE
        OF
        THE CONTROLS EVALUATION
  The
        CEO/CFO evaluation of our
        Disclosure Controls and Internal Controls included a review of the controls'
        objectives and design, the controls’ implementation by us and the effect of the
        controls on the information generated for use in this Annual Report. In the
        course of the Controls Evaluation, management sought to identify data errors,
        controls problems or acts of fraud and to confirm that appropriate corrective
        action, including process improvements, were being undertaken. This type
        of
        evaluation will be done on a quarterly basis so that the conclusions concerning
        controls effectiveness can be reported in our Quarterly Reports on Form 10-Q
        and
        Annual Report on Form 10-K. The overall goals of these various review and
        evaluation activities are to monitor our Disclosure Controls and Internal
        Controls and to make modifications as necessary; our intent in this regard
        is
        that the Disclosure Controls and the Internal Controls will be maintained
        as
        dynamic systems that change (including with improvements and corrections)
        as
        conditions warrant.
  
 76
 
 Among
        other matters, management sought
        in its evaluation to determine whether there were any "significant deficiencies"
        or "material weaknesses" in our Internal Controls, or whether we had identified
        any acts of fraud involving personnel who have a significant role in our
        Internal Controls. In the professional auditing literature, "significant
        deficiencies" are referred to as “reportable conditions;” these are control
        issues that could have a significant adverse effect on the ability to record,
        process, summarize and report financial data in the financial statements.
        A
        "material weakness" is defined in the auditing literature as a particularly
        serious reportable condition where the internal control does not reduce to
        a
        relatively low level the risk that misstatements caused by error or fraud
        may
        occur in amounts that would be material in relation to the financial statements
        and not be detected within a timely period by employees in the normal course
        of
        performing their assigned functions.
 
 Changes
        in Internal Control over Financial Reporting
 
 There
        were no changes to the Company’s
        internal control over financial reporting during the fourth quarter ended
        June
        30, 2007, that has materially affected, or are reasonably likely to materially
        affect the Company’s internal control over financial reporting.
 
 CONCLUSIONS
  Based
        upon the Controls Evaluation, our
        CEO and CFO have concluded that, as of the end of the period covered by this
        annual report, our Disclosure Controls are effective to provide reasonable
        assurance that our financial statements are fairly presented in conformity
        with
        generally accepted accounting principles.
  In
        June 2007, our independent
        auditors reported to our Audit Committee certain matters involving internal
        controls that our independent auditors considered to be a significant
        deficiency. A significant deficiency is a control deficiency or combination
        of
        control deficiencies, that adversely affects the company’s ability to initiate,
        authorize, record, process, or report external financial data reliably in
        accordance with generally accepted accounting principles such that there
        is more
        than a remote likelihood that a misstatement of the company’s annual or interim
        financial statements that is more than inconsequential will not be prevented
        or
        detected.
 
 The
        reportable condition related
        primarily to the analysis conducted in regards to the annual goodwill impairment
        testing.   Management is confident that our financial statements
        for the year ended June 30, 2007 fairly present, in all material respects,
        our
        financial condition and results of operations.
 
 The
        reportable condition has been
        discussed in detail among management, our Audit Committee and our independent
        auditors, and we are committed to addressing and resolving these matters
        fully
        and promptly, by putting in place the personnel, processes, technology and
        other
        resources appropriate to improve the communication between our subsidiary
        and
        the parent company as well as to provide better forecasting
        models.  As part of this commitment, in the second quarter of our
        fiscal year ending June 30, 2008, we will begin by educating the staff and
        revising the internal forecasting and reporting procedures to ensure that
        changes are provided in a timely manner to
        management.    Management will continue to evaluate these
        procedures to improve the process.
 
 
 **ITEM
        9B.               OTHER
        INFORMATION**
 
 None****
 
 
 77
 
 
 **PART
        III**
  **ITEM
                  10.**
              **DIRECTORS,
                  EXECUTIVE OFFICERS AND
                  CORPORATE
                  GOVERNANCE**
 
  
 Our
        executive officers and directors
        and their ages as of October 5, 2007, are as follows:
 
 Name
              Age
              Position
              Position
                  SincePhillip
                  C. Thomas (1)
                  (2)
              58
              President
                  and  Chief Executive Officer
              2007Stephen
                  N. Bunker (1)
              64
              Vice
                  President and Chief Scientist, Director
              1987Diane
                  J. Ryan (1)
              47
              Vice
                  President Finance
                and
                  Chief Financial Officer
              2003Walter
                  Wriggins (1)
              63
              Vice
                  President and General Manager
                Core
                  Systems
              2004Anthony
                  J. Armini (3)
              69
              Chairman
                  of the Board of Directors
              1984Michael
                  Szycher (5) (6)
                  (7)
              68
              Director
              1999David
                  B. Eisenhaure (5) (6)
                  (7)
              61
              Director
              2002Michael
                  Turmelle (4) (6)
                  (7)
              48
              Director
              2005
  (1)
                Executive
                    Officer
 (2)
                Promoted
                    to President and Chief Executive Officer in September
                    2007
 (3)
                Formerly
                    President and Chief Executive Officer through September
                    2007.
 Remains
                    Chairman of the Board of Directors
 (4)
                Chairman
                    of the Audit Committee
 (5)
                Member
                    of the Audit Committee for the fiscal year ended June 30,
                    2007
 (6)
                Member
                    of the Compensation Committee for the fiscal year ended June
                    30,
                    2007
 (7)
                Member
                    of the Nominating Committee for the fiscal year ended June 30,
                    2007
  There
        are no family relationships
        between any director, executive officer, or person nominated or chosen to
        become
        a director or executive officer.
 
 
 78
 
 
 *Phillip
        C. Thomas*has served as the Company’s Chief Executive Officer since
        September 2007, having joined the company in March 2007 as Chief Operating
        Officer.  Prior to joining Implant Sciences he served for eight years
        as CEO of DOBI Medical Systems.  He has also served as the Founder and
        CEO of Medication Delivery Devices Inc., a drug delivery company and as
        President of Mitek Systems, Inc. a NASDAQ high tech company which specialized
        in
        high security data products sold to the federal
        government.  Previously, he was the Director of the Federal Systems
        Division of Data General, Inc. and prior to that as a Product Line Manager
        at
        Wang Laboratories.  Mr. Thomas received his undergraduate degree from
        Brigham Young University.
  *Dr.
        Stephen N. Bunker* has
        served as the Company’s Vice President and Chief Scientist since 1987 and a
        Director since 1988. Prior to joining the Company, from 1972 to 1987, Dr.
        Bunker
        was a Chief Scientist at Spire Corporation. From 1971 to 1972, Dr. Bunker
        was an
        Engineer at McDonnell Douglas Corporation. Dr. Bunker received his Ph.D.
        in
        nuclear physics from the University of California, Los Angeles in 1969. Dr.
        Bunker is the author of sixteen patents with four more pending in the field
        of
        ion beam technology.
 
 *Diane
        J. Ryan*has served as
        the Company’s Vice President of Finance and Chief Financial Officer since May
        2003. Ms. Ryan has been employed with Implant Sciences Corporation since
        March
        1989. From March 2003 to May 2003, she was the Corporate Controller of the
        Company. Ms. Ryan graduated from Salem State College with a B.S. in Business
        Administration and a minor in management.
 
 *Walter
        J. Wriggins*has served
        as the Company’s Vice President and General Manager of Core Systems, since
        October 2004. Prior to his career at Core Systems, Mr. Wriggins had over
        22
        years experience in semiconductor industry. His career began as a materials
        scientist in the GE aircraft engine group, from which he transitioned to
        a sales
        and marketing career at various semiconductor companies throughout the country.
        These companies, at which he held senior management positions, include: Axcelis
        (formally Eaton Corporation), Applied Materials, Varian Thin Films, and Ion
        Implant Services. Mr. Wriggins received a B.A. in Applied Science, and a
        B.S. in
        Material Science and Engineering from Lehigh University and an MBA from Boston
        University.
 
 *Dr.
        Anthony J. Armini* has been
        the Company’s President, Chief Executive Officer (“CEO”), and Chairman of the
        Board of Directors since the Company’s incorporation. He retired as President
        and CEO on September 27, 2007.  From 1972 to 1984, prior to the
        Company’s founding, Dr. Armini was Executive Vice President at Spire
        Corporation. From 1967 to 1972, Dr. Armini was a Senior Scientist at McDonnell
        Douglas Corporation. Dr. Armini received his Ph.D. in nuclear physics from
        the
        University of California, Los Angeles in 1967. Dr. Armini is the author of
        twenty two patents and fourteen publications in this field. Dr. Armini has
        over
        thirty years of experience working with cyclotrons and linear accelerators,
        the
        production and characterization of radioisotopes, and over twenty years
        experience with ion implantation in the medical and semiconductor
        fields.  As of September 2007, Dr. Armini has stepped down from his
        position as President and Chief Executive Office and has assumed a new position
        within the organization.  Dr. Armini will remain on the Board of
        Directors until the next annual shareholders meeting.
 
 *Dr.
        Michael Szycher* joined the
        Company’s Board of Directors in December 1999. He has been President and Chief
        Executive Officer and Chairman of CardioTech International, Inc., a publicly
        traded manufacturer of medical devices and biocompatible polymers from 1996
        until August 2006.  From 1988 to 1996, Dr. Szycher was Chairman and
        Chief Technology Officer of Polymedica Industries. Dr. Szycher is a recognized
        authority on polyurethanes and blood compatible polymers. He is the editor
        of
        six books on various subjects in blood compatible materials and devices and
        the
        author of eighty original research articles.
 
 *David
        B. Eisenhaure* has served
        on the Company’s board of directors since November 2002. He has been the
        President, Chief Executive Officer and Chairman of the Board of SatCon
        Technology Corporation since 1985. From 1974 until 1985, Mr. Eisenhaure was
        associated with the Charles Stark Draper Laboratory, Incorporated and with
        its
        predecessor, the Massachusetts Institute of Technology's Instrumentation
        Laboratory, from 1967 to 1974. Dr. Eisenhaure also holds an academic position
        at
        M.I.T., as a lecturer in the Department of Mechanical Engineering. Mr.
        Eisenhaure serves on the board of directors of Mechanical Technology
        Incorporated and Beacon Power. He holds a S.B., S.M. and an Engineer's Degree
        in
        Mechanical Engineering from M.I.T.
 
 *Michael
        Turmelle* has served on
        the Company’s board of directors since December 2005. He is currently the Chief
        Financial Officer of Premium Power Corporation.  From 1987 until
        October of 2006 Mr. Turmelle worked for SatCon Technology Corporation holding
        several positions including Chief Financial Officer from 1991 until 2000
        and
        Chief Operating Officer from 2000 to 2005. Prior to SatCon Mr. Turmelle worked
        for HADCO Corporation.  Mr. Turmelle holds a B.A. degree in Economics
        from Amherst College.
  
 79
 
 CODE
        OF
        ETHICS
  The
        Company has adopted a code of
        ethics that applies to its directors, officers and employees and has been
        posted
        on the Company’s website: www.implantsciences.com.
  AUDIT
        COMMITTEE
  The
        Board has designated from among its
        members an Audit Committee, which consisted of Mr. Michael Turmelle (Chairman),
        Dr. Michael Szycher and Mr. David Eisenhaure, all of whom are independent
        members. Mr. Turmelle meets the requirements to qualify as a financial
        expert. The Audit Committee has the responsibility to ascertain that the
        Company’s financial statements reflect fairly the financial condition and
        operating results of the Company and to appraise the soundness, adequacy
        and
        application of accounting and operating controls. The Audit Committee recommends
        the independent auditors to the Board, reviews the scope of the audit functions
        of the independent auditors and reviews the audit reports.  In addition,
        the Audit Committee is responsible for reviewing and monitoring all related
        party transactions which may be entered into by the Company. The Audit Committee
        held a meeting each quarter during fiscal 2007. The responsibilities of the
        Audit Committee are outlined in a written charter available for review on
        the
        Company’s website: www.implantsciences.com.
 
 NOMINATING
        COMMITTEE
 
 The
        Board has designated from among its
        members a Nominating Committee, which consisted of Dr. Michael Szycher
        (Chairman), Mr. David Eisenhaure and Mr. Michael Turmelle, all of whom are
        independent members.  The Nominating Committee selects nominees for
        election as our directors. The committee will give the same consideration
        to a
        nominee for electing to the board of directors recommended by a stockholder
        of
        record if such recommendation is timely in accordance with, and is accompanied
        by the information required by the By-laws.
 
 SECTION
        16 COMPLIANCE
 
 Section
        16(a) of the Securities
        Exchange Act of 1934, as amended, requires our officers, directors and persons
        who beneficially own more than 10% of a registered class of our equity
        securities ("ten percent stockholders") to file reports of ownership and
        changes
        in ownership with the Securities and Exchange Commission. Officers, directors
        and ten percent stockholders are charged by the SEC regulations to furnish
        us
        with copies of all Section 16(a) forms they file.
 
 Based
        solely upon a review of Forms 3, 4, and 5 and amendments thereto furnished
        to us
        during the past fiscal year, and, if applicable, written representations
        that
        Form 5 was not required, we believe that all Section 16(a) filing requirements
        applicable to our officers, directors and ten percent stockholders were
        fulfilled.
 
 **ITEM
        11.                EXECUTIVE
        COMPENSATION**
 
 **Compensation
        Discussion and
        Analysis**
 
 This
        section discusses the material elements of compensation awarded to, earned
        by or
        paid to the executive officers identified in the Summary Compensation Table
        set
        forth below (whom we refer to as our named executive officers) in fiscal
        2007.
 
 The
        Compensation Committee of our Board of Directors generally has responsibility
        for reviewing and determining on both an annual and an as-needed basis the
        compensation of our named executive officers and key employees and reporting
        to
        the Board regarding the foregoing.  The Compensation Committee also
        has responsibility for administering our stock plans and determining the
        number
        of stock options, if any, to be granted under those plans and reporting to
        the
        Board regarding the foregoing.  None of the named executive officers
        are members of the Compensation Committee.
 
 The
        current Compensation Committee members are Messrs: Eisenhaure, Turmelle and
        Szycher.  Mr. Eisenhaure is the Committee Chairman.  Each
        member of the Compensation Committee qualifies as an independent director
        under
        the American Stock Exchange’s listing standards.
 
 
 80
 
 In
        this “Compensation Discussion and
        Analysis” section, the terms, "we," "our," "us," and the "Committee" refer to
        the Compensation Committee of our Board of Directors.
 
 *Overview
        of Compensation Programs and Objectives*
 
 The
        objectives of the Compensation Committee in recommending the levels and
        components of compensation for the named executive officers are to:
  (1)
                Attract,
                    motivate and retain talented and dedicated
                    executives;
 (2)
                Motivate
                    performance to achieve our established goals and objectives;
                    and
 (3)
                Provide
                    both cash and equity incentives that align the interests of the
                    named
                    executive officers with the long-term interests of our
                    stockholders.
  The
        Compensation Committee reviews the achievement of corporate goals and individual
        contributions to our success.  The Compensation Committee monitors the
        results of our executive compensation program to assure that the compensation
        paid to the named executive officers provides overall competitive pay levels
        and
        appropriately rewards superior performance.  The Compensation
        Committee relies on judgment and not upon rigid guidelines or formulas in
        determining the amount or mix of compensation elements for each named executive
        officer.  Factors affecting the Compensation Committee’s judgment
        include performance compared to strategic goals, the nature of the named
        executive officer’s responsibilities and his or her effectiveness in leading our
        initiatives to achieve our goals.  Our President and Chief Executive
        Officer, as the manager of the members of the executive team, assesses the
        executive officers’ individual contributions to their respective departmental
        goals and makes recommendations to the Compensation Committee with respect
        to
        increases in base salary, discretionary bonus and long-term incentive awards,
        for each member of the executive team.  The Compensation Committee
        evaluates, discusses and approves or modifies these
        recommendations.   Approval of each named executive officer’s
        compensation is made by the Compensation Committee and recommended to the
        Board
        for ratification.  As described in more detail below, the material
        components of the named executive officers’ compensation include base salary,
        discretionary bonus, long-term incentive awards, related severance protection,
        and other employee benefits.  The Compensation Committee believes that
        each element of our executive compensation program helps us to achieve one
        or
        more of our compensation objectives.
 
 Base
        salaries and other employee benefits are all primarily intended to attract
        and
        retain qualified executives.  The value of these components in any
        given year is less dependent on performance than the other elements that
        comprise our executive compensation package.  The Compensation
        Committee believes that we need to provide the named executive officers with
        a
        level of predictable compensation in order to attract and retain top-caliber
        executives and reward their continued services.  The Compensation
        Committee’s general philosophy is that discretionary bonuses and long-term
        incentive compensation should fluctuate with our success in achieving financial
        and other goals, and that we should continue to use long-term compensation
        such
        as stock options to align stockholder and executives’ interests.  The
        Compensation Committee also believes that a mix of longer-term and short-term
        elements allows us to achieve the dual goals of attracting and retaining
        executives while motivating their continued performance and aligning their
        financial interests with those of our stockholders.
 
 The
        Compensation Committee continues to place greater emphasis on the “performance”
approach to executive compensation, whereby the named executive officers,
        would
        receive salary increases based, in part, on individual and Company performance
        and on the results of an independent compensation study.
 
 The
        Compensation Committee uses relevant data points derived from independent
        compensation studies for comparable companies, such as salary surveys, to
        assist
        it in determining the compensation for each of our named executive
        officers.  While the Compensation Committee has found it difficult to
        benchmark the compensation levels of our named executive officers within
        a peer
        group of comparable companies due to the nature of our business and technology,
        it continues to evaluate the compensation practices of other companies in
        determining an appropriate level and mix of compensation.
 
 *Current
        Material Elements*
 
 *Base
        Salary.*  In determining the base salaries of our named executive
        officers in fiscal 2007, the Compensation Committee did not have a formal
        program to review base salary.  In setting the base salaries of our
        named executive officers for our fiscal year 2008, the Compensation Committee
        considered the performance of each named executive officer, including reviewing
        the nature of the named executive officer’s responsibilities, the Compensation
        Committee’s expectations for such named executive officer’s performance, and our
        past compensation practice.  Base salary is paid in cash.
 
 81
 
 
 *Discretionary
        Bonuses.*  There were discretionary bonus programs in place in
        fiscal 2007 for certain of our named executive officers. These amounts are
        disclosed in the Summary Compensation Table.
 
 The
        Compensation Committee may recommend at the beginning of fiscal 2008 that
        discretionary bonuses be paid on an individual basis to a particular named
        executive officer using criteria which the Compensation Committee believes
        to be
        relevant, such as the performance of the particular officer or the
        accomplishment of specific objectives by such officer, as well as other factors
        such as our profitability, revenue, cash flow, customer generation, market
        share
        and industry position.
 
 *Long-Term
        Incentive Compensation.*There was not a formal discretionary long term
        incentive compensation program in place in fiscal 2007.  Periodically,
        the Compensation Committee grants long-term incentive compensation, in the
        form
        of stock option grants, to our named executive officers in order to provide
        a
        long-term incentive which is directly tied to the performance of our
        stock.  These grants provide an incentive to maximize stockholder
        value by providing the executives an equity interest which further aligns
        their
        interests with those of the stockholders.  Vesting periods associated
        with such grants are used to retain our named executive officers and to
        emphasize the long-term aspect of contribution and performance.
 
 Beginning
        in fiscal 2008, in making grants of long-term incentive compensation in the
        form
        of stock option grants to our named executive officers, the Compensation
        Committee will consider a number of factors, including our performance, the
        performance of such persons, the achievement of specific delineated goals,
        the responsibilities of such persons, the number of stock options and other
        awards each such person currently possesses and the underlying value of the
        options and other awards held.  Stock option grants are issued
        pursuant to the terms of the 2004 and 2000 Stock Option Plans, which have
        previously been approved by our stockholders.
 
 *Stock
        Options*.  Pursuant to the terms of the 2004 Plan, Mr. Phillip C.
        Thomas received stock option grants at the time he joined the Company in
        March
        2007.  In addition, Diane J. Ryan and Walter J. Wriggins each received
        stock options pursuant to the 2004 Plan during fiscal 2007.  No other
        named executive officers received stock option grants in fiscal
        2007.  When issued, the exercise price of grants is 100% of the
        closing price of the underlying Common Stock on the date of grant.  In
        general, the options granted to our named executive officers vest in three
        equal
        annual installments over a three-year period beginning on the anniversary
        date
        of the date of grant.  The Compensation Committee may, in certain
        instances, grant performance-based options, though it has not done so to
        date.
 
 *Equity
        Grant Practices*.  The Compensation Committee may grant awards to
        our named executive officers or other eligible participants under our 2004
        or
        2000 Stock Plans at any time during the year, including in connection with
        the
        hiring or promotion of employees or based upon other special circumstances
        or
        performance.  In accordance with longstanding policy, the Compensation
        Committee does not backdate or re-price options or grant options
        retroactively.  In addition, the Compensation Committee does not
        coordinate grants of options so that they are made before announcements of
        favorable information, or after announcements of unfavorable
        information.  Options are granted at fair market value (deemed to be
        the closing price of the underlying Common Stock on the date of grant) on
        a
        fixed date or event (such as a bi-annual grant schedule for existing employees
        or upon a new employee’s first day of work) with all required approvals obtained
        in advance of or on the actual grant date.
 
 *Change
        in Control Benefits and Severance Protection.* Certain of our
        named executives have stock option grants which provide for acceleration
        of
        vesting in the event of a change of control of the Company. The executives
        shall
        be entitled to receive shares of common stock, or if applicable, shares of
        such
        other Stock or securities, cash or property as the holders of shares of common
        stock received pursuant to the terms of the change in control transaction.
        In
        addition, certain of our named executive officers have entered into employment
        agreements providing severance protection in the event of termination by
        the
        Company of the Named Executive Officer without Cause.  The Severance
        Protection provisions are further described below in “Employment Agreements.”
The expense for this severance is estimated to be $263,000 at June 30,
        2007.
 
 *Other
        Compensation and Benefits.*Our named executive officers
        participate in the same group insurance and employee benefit plans customarily
        offered to our other employees.  As a policy, we do not provide loans
        to our named executive officers.
 
 
 82
 
 *Employment
        Agreements.*
 
 As
        of
        June 30, 2007, among the named executive officers, the President and Chief
        Executive Officer, the Vice President and Chief Scientist and the Vice President
        and General Manager of Core Systems have employment agreements as described
        in
“Employment Agreements”.
 
 *Stock
        Ownership Guidelines*
 
 The
        Company currently does not require our directors or named executive officers
        to
        own a particular amount of our Common Stock.  The Compensation
        Committee recommends stock and option holdings to our directors and named
        executive officers to provide motivation to this group and to align their
        interests with those of our stockholders.  The majority of our
        directors and named executive officers are stockholders.
 
 *Return
        of Incentive Compensation by an Executive*
 
 In
        the
        case of a significant restatement of our financial results, the Board may
        take
        action to seek reimbursement of any portion of performance-based or incentive
        compensation that was paid or awarded which would not have been paid or awarded
        if such compensation had been calculated based on the restated financial
        results.  The Audit Committee of the Board will determine whether a
        financial restatement is significant and will make an initial determination
        of
        the effect of the restatement on the performance-base or incentive
        compensation.
 
 *Compensation
        Consultant*
 
 From
        time
        to time the company or the Compensation Committee may contractually engage
        or
        seek the advice of one or more compensation consultants; however, such
        consultants have no role in deciding the amount or form of named executive
        officer or director compensation.
 *Tax
        Consideration*
 
 The
        Compensation Committee currently intends for all compensation paid to our
        named
        executive officers to be tax deductible to us pursuant to Section 162(m)
        of the
        Internal Revenue Code of 1986, as amended (“Section 162(m)”).  Section
        162(m) provides that we cannot deduct  for Federal income tax purposes
        compensation paid to our named executive officers in excess of $1,000,000,
        unless, in general, (1) such compensation is performance-based, established
        by a
        committee of outside directors and objective, and (2) the plan or agreement
        providing for such performance-based compensation has been approved in advance
        by stockholders.  The Compensation Committee believes that stockholder
        interests are best served by not restricting the Committee’s discretion and
        flexibility in crafting compensation programs, even though such programs
        may
        result in certain non-deductible compensation expenses.  Accordingly,
        in the future, the Compensation Committee may determine to adopt a compensation
        program that does not satisfy the conditions of Section 162(m) if in its
        judgment, after considering the additional costs of not satisfying Section
        162(m), such program is appropriate.  However, the Compensation
        Committee does not anticipate paying any named executive officers in excess
        of
        $1,000,000 in the near term.
 
 
 **COMPENSATION
        COMMITTEE REPORT**
  The
        Compensation Committee has reviewed and discussed the above Compensation
        Discussion and Analysis with management.  Based on its review and
        discussions with management, the Compensation Committee recommended to our
        Board
        of Directors that the Compensation Discussion and Analysis be incorporated
        by
        reference in the Company’s Annual Report on Form 10-K for the year ended June
        30, 2007.
  Compensation
                    Committeeof
                    the Board of DirectorsDavid
                    Eisenhaure, ChairmanMichael
                    TurmelleMichael
                    Szycher
 83
  The
        following table sets forth the
        aggregate cash compensation paid by us with respect to the three fiscal years
        ended June 30, 2005, 2006 and 2007 to our executive officers:
  **SUMMARY
                      COMPENSATION TABLE**Name
                      and Principal Position
                  Year
                  Salary($)
                  Bonus
                      ($)
                  Stock
                      Awards($)
                  Option
                      Awards($)
                  Non-Equity
                      Incentive Plan Compensation
                  Non-Qualified
                      Deferred Compensation Earnings
                  Other
                      Annual Compensation($)(1)
                  TotalAnthony
                      J. Armini (2)
                  2007
                  $242,790
                  -
                  -
                  -
                  -
                  -
                  $22,628
                  $265,418President,
                      Chief Executive Officer and Chairman
                  2006
                  $214,712
                  -
                  -
                  $196,000
                  -
                  -
                  $12,353
                  $423,0652005
                  $213,101
                  -
                  -
                  -
                  -
                  -
                  $15,417
                  $228,518Stephen
                      N. Bunker
                  2007
                  $110,254
                  -
                  -
                  -
                  -
                  -
                  $1,102
                  $111,356Vice
                      President,
                  2006
                  $55,814
                  -
                  -
                  $137,000
                  -
                  -
                  $1,100
                  $193,914Chief
                      Scientist and Director
                  2005
                  $103,377
                  -
                  -
                  -
                  -
                  -
                  $1,077
                  $104,454Phillip
                      C. Thomas(3)
                  2007
                  $57,692
                  -
                  -
                  $177,600
                  -
                  -
                  $2,489
                  $237,781President
                      and Chief
                  2006
                  -
                  -
                  -
                  -
                  -
                  -
                  -
                  -Executive
                      Officer
                  2005
                  -
                  -
                  -
                  -
                  -
                  -
                  -
                  -Diane
                      J. Ryan
                  2007
                  $145,116
                  $18,750
                  -
                  $72,950
                  -
                  -
                  $1,220
                  $238,036Vice
                      President Finance and
                  2006
                  $137,308
                  -
                  -
                  $213,500
                  -
                  -
                  $1,217
                  $352,025Chief
                      Financial Officer
                  2005
                  $120,393
                  $25,000
                  -
                  -
                  -
                  -
                  $1,147
                  $146,540Walter
                      J. Wriggins(4)
                  2007
                  $140,000
                  $20,000
                  -
                  $28,500
                  -
                  -
                  $4,450
                  $192,950Vice
                      President and General
                  2006
                  $139,462
                  -
                  -
                  $77,400
                  -
                  -
                  $1,231
                  $218,093Manager,
                      Core Systems
                  2005
                  $101,124
                  -
                  -
                  -
                  -
                  -
                  -
                  $101,124
 (1)
                    Other annual compensation consists of life and disability insurance
                    premiums and 401(k) plan beneftis paid by us on behalf of these
                    executive
                    officers.  In addition, Dr. Armini, Mr. Thomas and Mr. Wriggins
                    received a car allowance of $8,993, $2,250 and $3,600
                    respectively.(2)
                    Dr. Armini stepped down and President and CEO on September 27,
                    2007.  He remains Chairman of the Board.(3)
                    Joined the Company in March 2007.  Promotoed to CEO on September
                    27, 2007.(4)
                    Joined the Company in October 2004.


84
  **Employment
        Agreements**
 
 *Anthony
        J. Armini.* On June 30,
        2004, we entered into an employment agreement, with an initial term of three
        years and an automatic renewal for a successive period of three years, unless
        we
        or Dr. Armini give the other party not less than three months written notice
        of
        non-renewal. Under this employment agreement, Dr. Armini serves as our president
        and chief executive officer at a base salary of up to $210,000 and is subject
        to
        increase as authorized by the Compensation Committee. In addition, Dr. Armini
        may participate in our employee fringe benefit plans or programs generally
        available to employees of comparable status and position. We are entitled
        to
        terminate his employment for any material breach of his employment agreement
        at
        any time upon at least 30 days written notice. In the event we terminate
        Dr.
        Armini’s employment without cause, we will pay him 12 months’ salary. Under his
        employment agreement, he is subject to restrictive covenants, including
        confidentiality provisions. Also, during his employment and for a period
        of two
        years after the term of the employment agreement, Dr. Armini is subject to
        a
        non-competition provision.
 
 On
        September 27, 2007, the Company and
        Dr. Armini entered into a Transition Agreement with a term of twenty four
        months.  Under this Transition Agreement Dr. Armini stepped down as
        President and Chief Executive Officer and assumed the position of Scientific
        Advisor.  Dr. Armini will remain the Chairman of the Board of
        Directors until the next annual meeting of shareholders.  During the
        Transition Period, the Company will compensate Dr. Armini at the annual rate
        of
        $250,000.  In addition, Dr. Armini may participate in the Company’s
        medical and dental insurance programs.  The Company may terminate this
        Transition Agreement only for cause and Dr. Armini may terminate the Transition
        Agreement for any reason, with each party giving the other written
        notice.  In conjunction with this, Dr. Armini has been issued a stock
        option for 200,000 shares which vest over the term of the Transition
        Agreement.  Dr. Armini will be subject to non-competition and
        confidentiality provisions.
 
 *Stephen
        N. Bunker.* On June 30,
        2004, we entered into an employment agreement, with an initial term of three
        years and an automatic renewal for a successive period of three years, unless
        we
        or Dr. Bunker give the other party not less than three months written notice
        of
        non-renewal. No such notice was given at June 30, 2007.  Under this
        employment agreement, Dr. Bunker serves as our vice president and chief
        executive scientist at a base salary of up to $150,000 and is subject to
        increase as authorized by the Compensation Committee. In addition, Dr. Bunker
        may participate in our employee fringe benefit plans or programs generally
        available to employees of comparable status and position. We are entitled
        to
        terminate his employment for any material breach of his employment agreement
        at
        any time upon at least 30 days’ written notice. In the event we terminate Dr.
        Bunker’s employment without cause, we will pay him 12 months’ salary. Under his
        employment agreement, he is subject to restrictive covenants, including
        confidentiality provisions. Also, during his employment and for a period
        of two
        years after the term of the employment agreement, Dr. Bunker is subject to
        a
        non-competition provision.
 
 *Walter
        J. Wriggins.* On October
        15, 2004, we entered into an employment agreement, with an initial term of
        one
        years and an automatic renewal for a successive period of one year, unless
        we or
        Mr. Wriggins give the other party not less than thirty days written notice
        of
        non-renewal. Under this employment agreement, Mr. Wriggins serves as our
        Vice
        President of Business Development/Operations and general manager of Core
        Systems at a base salary of $140,000. In addition, Mr. Wriggins may participate
        in our employee fringe benefit plans or programs generally available to
        employees of comparable status and position. We are entitled to terminate
        his
        employment for any material breach of his employment agreement at any time
        upon
        at least 30 days’ written notice. In the event we terminate Mr. Wriggins’
employment without cause, we will pay him the balance of the salary due for
        the
        term of the agreement. Under his employment agreement, he is subject to
        restrictive covenants, including confidentiality provisions. Also, during
        his
        employment and for a period of two years after the term of the employment
        agreement, Mr. Wriggins is subject to a non-competition provision.
 
 *Phillip
        C.
        Thomas.*On March 12, 2007, we entered into an employment
        agreement whereby should Mr. Thomas’ employment be terminated for reasons other
        than cause during his first year of service, he will be paid six months base
        salary in compensation and one year of base compensation after one year of
        service.
 
 **Director
        Compensation**
  Our
        directors who are our employees do
        not receive any compensation for service on the board of directors. Directors,
        who are not our employees, are paid a yearly stipend of $6,000 and are
        reimbursed for reasonable travel expenses incurred in connection with attendance
        at board and committee meetings.  In addition, each independent Board
        member who attends a special board meeting is paid $750 per
        meeting.
 
 85
  Under
        the 2004 incentive and
        nonqualified stock option plan, each director who is not our employee,
        automatically receives an annual grant of options to purchase 10,000 shares
        of
        our common stock at an exercise price equal to the closing price of the common
        stock on the date of election to the Board.  Each such option will
        have a term of ten years and will vest in full on the date of the
        grant.
  **Stock
        Option and Purchase Plans**
 
 In
        September 1998, the Company adopted
        the 1998 Stock Option Plan (the “1998 Plan”). The 1998 Plan provides for the
        grant of incentive stock options and nonqualified stock options to employees
        and
        affiliates. The exercise price of the options equals 100% or 110% of the
        fair
        market value on the date of the grant. Options expire ten years from the
        date of
        the option grant and vest ratably over a three-year period commencing with
        the
        second year. A total of 280,000 options were reserved for issuance under
        the
        1998 Plan. Upon adoption of the 1998 Plan, the 1992 Stock Option Plan was
        terminated.
 
 In
        December 2000, the Company adopted
        the 2000 Incentive and Non Qualified Stock Option Plan (the “2000 Plan”). The
        2000 Plan provides for the grant of incentive stock options and nonqualified
        stock options to employees and affiliates. The exercise price of the options
        equal 100% of the fair market value on the date of the grant or 110% of the
        fair
        market value for greater than 10% beneficial owners of the Company stock.
        Options expire between five and ten years from the date of the option grant
        and
        have variable vesting periods. A total of 600,000 options were originally
        reserved for issuance under the 2000 Plan. In December 2003, the stockholders
        of
        the Company approved an increase in the 2000 Incentive and Non-Qualified
        Stock
        Option Plan from 600,000 shares to 1,000,000 shares. In December 2004, the
        stockholders of the Company approved an increase in the 2000 Incentive and
        Non-Qualified Stock Option Plan from 1,000,000 shares to 1,500,000
        shares.
 
 In
        December 2004, the Company adopted
        the 2004 Stock Option Plan. The 2004 Plan provides for the grant of incentive
        stock options and nonqualified stock options to employees and affiliates.
        A
        total of 500,000 options were originally reserved for issuance under the
        2000
        Plan. The exercise price of the options equa1 100% of the fair market value
        on
        the date of the grant or 110% of the fair market value for greater than 10%
        beneficial owners of the Company stock. Options expire between five and ten
        years from the date of the option grant and have variable vesting periods.
        In
        December 2005, the stockholders of the Company approved an increase in the
        2004
        Incentive and Non-Qualified Stock Option Plan from by 500,000 shares to
        1,000,000 shares. As of June 30, 2007, a total of 137,003, 245,602 and 278,000
        shares are available for issuance under the 1998, 2000 and 2004 stock option
        plans, respectively.
  The
        Board of Directors administers the
        Stock Plan. Subject to the provisions of the Stock Plan, the Board of Directors
        has the authority to select the optionees or restricted stock recipients
        and
        determine the terms of the options or restricted stock granted, including:
        (i)
        the number of shares, (ii) option exercise terms, (iii) the exercise or purchase
        price (which in the case of an incentive stock option cannot be less than
        the
        market price of the Common Stock as of the date of grant), (iv) type and
        duration of transfer or other restrictions and (v) the time and form of payment
        for restricted stock and upon exercise of options. Generally, an option is
        not
        transferable by the option holder except by will or by the laws of descent
        and
        distribution. Also, as defined by the specific plans’ provisions, options must
        be exercised within 60 or 90 days following termination of employment, 90
        days
        in cases of retirement, and between 6 and 12 months in the case of disability.
        However, in the event that termination is due to death, the exercise period
        varies by plan and ranges between 180 days and the expiration date of the
        grant.
 
 In
        September 1998, the Company adopted
        the 1998 Employee Stock Purchase Plan (the “Plan”). The Plan provides a method
        whereby employees of the Company will have an opportunity to acquire an
        ownership interest in the Company through the purchase of shares of common
        stock
        of the Company through payroll deductions. After 12 months of employment,
        an
        employee is eligible to participate and can defer up to 10% of their wages
        into
        this Plan, with a maximum of $25,000 in any calendar year. The purchase price
        of
        the common stock is calculated at the lower of 85% of the closing price of
        the
        stock on the first day of the plan period or the last day of the plan period.
        The periods are January 1 to June 30 and July 1 to December 31. Fractional
        shares are not issued. Participants may withdraw at any time by giving written
        notice to the Company and will be credited the amounts of deferrals in their
        account. The maximum number of shares eligible to be issued under the Plan
        is
        141,000. As of June 30, 2007, a total of 10,669 shares are available for
        issuance under the Plan.
  86
  In
        December 2006, the Company adopted
        the 2006 Employee Stock Purchase Plan (the “2006 Plan”). The 2006 Plan provides
        a method whereby employees of the Company will have an opportunity to acquire
        an
        ownership interest in the Company through the purchase of shares of common
        stock
        of the Company through payroll deductions. After 12 months of employment,
        an
        employee is eligible to participate and can defer up to 10% of their wages
        into
        this Plan, with a maximum of $25,000 in any calendar year. The purchase price
        of
        the common stock is calculated at the lower of 85% of the closing price of
        the
        stock on the first day of the plan period or the last day of the plan period.
        The periods are January 1 to June 30 and July 1 to December 31. Fractional
        shares are not issued. Participants may withdraw at any time by giving written
        notice to the Company and will be credited the amounts of deferrals in their
        account. The maximum number of shares eligible to be issued under the 2006
        Plan
        is 500,000. As of June 30, 2007, a total of 481,023 shares are available
        for
        issuance under the 2006 Plan.
 
 87
  **OPTION
        GRANTS IN FISCAL 2007**
  The
        following table sets forth certain
        information regarding stock options granted in the fiscal year ended June
        30,
        2007 to the executive officers.
  Estimated
                      Future Payouts Under Non-Equity Incentive Plan Awards
                  Estimated
                      Future Payouts Under Equity Incentive Plan AwardsName
                  Grant
                      Date
                  Threshold
                      ($)
                  Target
                      ($)
                  Maximum
                      ($)
                  Threshold
                      ($)
                  Target
                      ($)
                  Maximum
                      ($)
                  All
                      other Stock Awards:  Number of Shares of Stocks or
                      Units
                  All
                      other Option Awards:  Number of Securities Underlying Options
                      (#)
                  Exercise
                      of Base Price of Option Awards ($/sh)(a)
                  (b)
                  (c)
                  (d)
                  (e)
                  (f)
                  (g)
                  (h)
                  (i)
                  (j)
                  (k)Phillip
                      C. Thomas
                  3/12/2007
                  -
                  -
                  -
                  120,000
                  120,000
                  120,000
                  -
                  -
                  $2.12Diane
                      J. Ryan
                  8/31/2006
                  -
                  -
                  -
                  20,000
                  20,000
                  20,000
                  -
                  -
                  $2.403/5/2007
                  -
                  -
                  -
                  25,000
                  25,000
                  25,000
                  -
                  -
                  $2.05Walter
                      Wriggins
                  6/29/2007
                  -
                  -
                  -
                  25,000
                  25,000
                  25,000
                  -
                  -
                  $1.64
 
 
 88
 
 **OUTSTANDING
        EQUITY AWARDS**
 
 
 The
        following table shows outstanding equity awards at June 30, 2007:
  Name
                Number
                    of Securities Underlying Unexercised Options (#)
                    Exercisable
                Number
                    of Securities Underlying Unexercised Options (#)
                    Unexercisable
                Equity
                    Incentive Plan Awards:  Number of Securities Underlying
                    Unexercised Unearned Options (#)
                Option
                    Exercise Price
                Option
                    Expiration
                Number
                    of Shares or Units of Stock that Have not Vested (#)
                Market
                    Value of Shares or Units of Stock That Have Not Vested ($)
                Equity
                    Incentive Plan Awards:  Number of Unearned Shares, Units or
                    Other Rights That Have Not Vested (#)
                Equity
                    Incentive Plan Awards:  Market or Payout Value of Unearned
                    Shares, Units or Other Rights That have not Vested ($)(a)
                (b)
                (c)
                (d)
                (e)
                (f)
                (g)
                (h)
                (i)
                (j)Anthony
                    J. Armini
                48,000
                -
                -
                $4.65
                11/11/2007
                -
                -
                -
                -10,200
                -
                -
                $2.31
                3/4/2008
                -
                -
                -
                -50,000
                -
                -
                $6.96
                8/22/2008
                -
                -
                -
                -100,000
                -
                -
                $4.50
                12/13/2010
                -
                -
                -
                -Stephen
                    N. Bunker
                50,000
                -
                -
                $4.65
                11/11/2007
                -
                -
                -
                -50,000
                -
                -
                $6.33
                8/22/2013
                -
                -
                -
                -50,000
                -
                -
                $4.09
                12/13/2015
                -
                -
                -
                -Phillip
                    C. Thomas
                -
                120,000
                -
                $2.12
                3/12/2017
                -
                -
                -
                -Diane
                    J. Ryan
                5,000
                -
                -
                $10.90
                4/4/2012
                -
                -
                -
                -20,000
                -
                -
                $4.23
                11/11/2012
                -
                -
                -
                -4,000
                -
                -
                $2.10
                3/4/2013
                -
                -
                -
                -21,800
                -
                -
                3.16
                5/21/2013
                -
                -
                -
                -50,000
                -
                -
                $6.33
                8/22/2013
                -
                -
                -
                -20,100
                9,900
                -
                $9.15
                7/28/2014
                -
                -
                -
                -30,000
                -
                -
                $3.80
                11/1/2015
                -
                -
                -
                -50,000
                -
                -
                $4.09
                12/13/2015
                -
                -
                -
                --
                20,000
                -
                $2.40
                8/31/2016
                -
                -
                -
                --
                25,000
                -
                $2.05
                3/5/2017
                -
                -
                -
                -Walter
                    J. Wriggins
                33,500
                16,500
                -
                $9.92
                10/15/2014
                -
                -
                -
                -13,400
                6,600
                -
                $3.58
                4/22/2015
                -
                -
                -
                -30,000
                -
                -
                $3.89
                10/31/2015
                -
                -
                -
                --
                25,000
                -
                $1.64
                6/29/2017
                -
                -
                -
                -
 89
 
 **Option
        Exercises and Stock Vested for fiscal 2007**
 
 
 Not
        applicable
 
 
 **Nonqualified
        Deferred Compensation for fiscal 2007**
 
 Not
        applicable
 
 
 
 The
        following table shows the details of compensation paid to outside directors
        of
        the Company during 2007:
 
 **Director
        Compensation for fiscal 2007**
   Name
                Fees
                    Earned or Paid in Cash ($)
                Stock
                    Awards ($)
                Option
                    Awards ($)
                Non-Equity
                    Incentive Plan Compensation
                Change
                    in Pension Value and Nonqualified Deferred Compensation
                    Earnings
                All
                    Other Compensation ($)
                Total
                    ($)(a)
                (b)
                (c)
                (d)
                (e)
                (f)
                (g)
                (h)Michael
                    Szycher
                13,500
                -
                16,200
                -
                -
                -
                29,700David
                    Eisenhaure
                12,000
                -
                16,200
                -
                -
                -
                28,200Michael
                    Turmelle
                13,500
                -
                16,200
                -
                -
                -
                29,700
 
 COMPENSATION
                  COMMITTEE
  The
        Compensation Committee, which met
        two times during fiscal 2007, had all members, Mr. David Eisenhaure (Chairman),
        Mr. Michael Turmelle and Dr. Michael Szycher present, all of whom are
        independent board members. The Compensation Committee reviews and determines
        on
        both an annual and an as-needed basis the compensation of the Company’s chief
        executive officer (the “CEO”).  The Compensation Committee determines all
        elements of the CEO’s compensation, including salary, bonus, options, benefits
        and all other aspects of the total compensation package based on the
        compensation earned by a CEO in a similar corporation and industry. Additional
        responsibilities of the Compensation Committee are outlined in a written
        charter
        available for review on the Company’s website:
www.implantsciences.com.
 
 COMPENSATION
                  COMMITTEE INTERLOCKS AND INSIDER
                  PARTICIPATION
  No
        person serving on the Compensation
        Committee at any time during fiscal 2007 was a present or former officer
        or
        employee of the Company or any of its subsidiaries. During fiscal 2007, other
        than Dr. Armini, no executive officer of the Company served as a member of
        the board of directors or compensation  committee (or other board committee
        performing equivalent functions) of another entity. During fiscal 2007,
        Dr. Armini served on the board of directors of Cardio-tech
        International.
  **ITEM
                  12.**
              **SECURITY
                  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND****MANAGEMENT
                  AND RELATED STOCKHOLDER
                  MATTERS**
  The
        following table sets forth information as of October 5, 2007, with respect
        to
        the beneficial ownership of our common stock of each director and nominee
        for
        director, each named executive officer in the executive compensation table
        above, all of our directors and current officers as a group, and each person
        known by us to be a beneficial owner of five percent or more of our common
        stock. This information is based upon information received from or on behalf
        of
        the individuals named therein.
 90
 
 **Name
                  of Beneficial Owner**
              **Number
                  of Shares Beneficially Owned (1)**
              **Percent
                  of Class (2)**Officers
                  and Directors as a group
              12,629,561
              21%Anthony
                  J. Armini (3)
              1,412,889
              11%Stephen
                  N. Bunker(4)
              751,048
              6%Diane
                  J. Ryan (5)
              238,642
              2%Walter
                  J. Wriggins (6)
              106,114
              1%Michael
                  Szycher (7)
              81,000
              1%David
                  Eisenhaure (8)
              76,000
              1%Michael
                  Turmelle(9)
              20,000
              1%
 
 (1)
              Unless
                  otherwise noted, each person identified possesses sole voting and
                  investment power over the shares(2)
              The
                  calculation of percentage of class is based on 11,835,661shares
                  of common
                  stock issued and outstanding as of October 5, 2007 plus any shares
                  issuable upon exercise of options, to such persons and included
                  as being
                  beneficially owned by him.(3)
              Includes
                  229,200 shares exercisable within 60 days of the date
                  hereof.(4)
              Includes
                  150,000 shares exercisable within 60 days of the date
                  hereof.(5)
              Includes
                  210,800 shares exercisable within 60 days of the date
                  hereof.(6)
              Includes
                  76,900 shares exercisable within 60 days of the date
                  hereof.(7)
              Includes
                  79,000 shares exercisable within 60 days of the date
                  hereof.(8)
              Includes
                  75,000 shares exercisable within 60 days of the date
                  hereof.(9)
              Includes
                  20,000 shares exercisable within 60 days of the date
                  hereof.
 
  **ITEM
                  13.**
              **CERTAIN
                  RELATIONSHIPS AND RELATED
                  TRANSACTIONS**
  Our
        Chairman of the Board of Directors
        is also a director of CardioTech.
 
 In
        March 2000, the Company entered into
        a joint research agreement with CardioTech to develop a proprietary porous
        polymer biocompatible coating technology as a platform for the Company’s
        proprietary radioactive brachytherapy technology. In consideration for this
        agreement, the Company agreed to pay $150,000 in cash and purchase 100,000
        shares of CardioTech stock at a price of $1.00 per share. As of June 30,
        2007,
        the Company has purchased these shares, the fair market value of which is
        $133,000 and is recorded as investments in available for sale securities
        in the
        accompanying consolidated balance sheet.
  In
        March 2004 the Company
        entered into an Exchange & Venture Agreement with CardioTech International,
        Inc. (“CardioTech”), a public company and related party of the Company, and
        CorNova, Inc. (“CorNova”). CorNova is a start-up company incorporated as a
        Delaware corporation on October 12, 2003. CorNova’s focus is the development and
        marketing of innovative interventional cardiology products. In connection
        with
        the agreement, in March 2004, the Company and CardioTech issued 10,344 and
        12,931 shares, respectively, of their respective common stock (the “Contributory
        Shares”) bearing an aggregate fair market value of $113,000 and $76,000,
        respectively, as of the date of the issuance. In exchange, the Company and
        CardioTech each received 1,500,000 shares of CorNova’s common stock, which
        represented a 30% ownership position for each party. In February 2005, upon
        CorNova’s securing of an additional $3,000,000 in financing (“Series A”),
        CardioTech and the Company each issued additional shares of their common
        stock,
        which was equal in value to twenty-five percent (25%) of the gross proceeds
        of
        the Series A Financing, or $750,000. As of June 30, 2007,
        the Company’s shares,
        represent a 16.2%
        ownership
        position.
 
 91
  **ITEM
        14.                 PRINCIPAL
        ACCOUNTANT FEES AND SERVICES**
 
 June
                    30,2007
                
                
                2006Audit
                    fees
                
                $
                196,000
                
                
                $
                173,500Audit
                    related fees
                
                
                95,000
                
                
                
                65,500Tax
                    fees
                
                
                -
                
                
                
                -Other
                    fees
                
                
                23,000
                
                
                
                63,000$
                314,000
                
                
                $
                302,000
 
 The
        firm of UHY LLP ("UHY") acts as our
        principal independent registered public accounting firm. Through June 30,
        2007,
        UHY had a continuing relationship with UHY Advisors, Inc. (“Advisors”) from
        which it leased auditing staff who were full time, permanent employees of
        Advisors and through which UHY’s partners provide non-audit services. UHY has no
        full time employees and therefore, none of the audit services performed were
        provided by permanent full-time employees of UHY. UHY manages and supervises
        the
        audit services and audit staff, and is exclusively responsible for the opinion
        rendered in connection with its examination.
  The
        Company’s Audit Committee must
        pre-approve all audit services to be provided to the Company, whether provided
        by the principal auditor or other firms, and all other services (review,
        attest
        and non-audit) to be provided to the Company by the independent auditor,
        provided, however, that *de minimis* non-audit services may instead be
        approved in accordance with applicable SEC rules. The Company’s principal
        financial and accounting officer communicates to both the Chairman of the
        Audit
        Committee and the auditing services firm any services requested to be provided.
        After receiving a fee quote for services from the service provider, a letter
        from the Chairman of the Audit Committee is prepared and submitted to the
        service provider as evidence of approval of the requested services.
 92
 **ITEM
        15.                 EXHIBIT
        INDEX**
 
 The
                  following are filed as part of this Form10-KExhibit
                  No.
              Ref.
                  No.
              Description3.2
              1
              By-Laws
                  of the Company.3.3
              1
              Articles
                  of Amendment to the Articles of Organization of the Company, dated
                  June 9,
                  1999.3.4
              1
              Restated
                  Articles of Organization of the Company, dated June 9.
                  1999.3.5
              5
              Certificate
                  of Vote of Directors establishing Series A 7% Cumulative Convertible
                  Preferred Stock, dated October 7, 2002.3.6
              6
              Certificate
                  of Vote of Directors establishing Series B 5% Cumulative Convertible
                  Preferred Stock, dated August 26, 2003.3.7
              7
              Certificate
                  of Vote of Directors establishing Series C 5% Cumulative Convertible
                  Preferred Stock, dated November 25, 2003.3.8
              19
              Certificate
                  of Vote of Directors establishing Series D Convertible Preferred
                  Stock,
                  dated September 30, 2005.3.9
              20
              Form
                  of Amendment to Series D Cumulative Convertible Preferred Stock
                  and
                  Securities Purchase Agreement dated May 31, 2006.4.1
              2
              Specimen
                  certificate for the Common Stock of the Company.10.01
              1
              1992
                  Stock Option Plan.10.02
              1
              Form
                  of Stock Option Agreement under the 1992 Stock Option
                  Plan.10.03
              1
              1998
                  Incentive and Nonqualified Stock Option Plan.10.04
              2
              Form
                  of Incentive Stock Option under the 1998 Incentive and Nonqualified
                  Stock
                  Option Plan.10.05
              2
              Form
                  of Nonqualified Stock Option under the 1998 Incentive and Nonqualified
                  Stock Option Plan.10.06
              2
              Form
                  of Nonqualified Stock Option for Non-Employee Directors under the
                  1998
                  Incentive and Nonqualified Stock Option Plan.10.07
              5
              Common
                  Stock Purchase Warrant for 55,000 shares issued to Laurus Master
                  Fund,
                  Ltd. Dated October 7, 2002.10.08
              6
              Common
                  Stock Purchase Warrant for 70,000 shares issued to Laurus Master
                  Fund,
                  Ltd. Dated August 28, 2003.10.09
              7
              Securities
                  Purchase Agreement between Implant Sciences Corporation and Laurus
                  Master
                  Fund, Ltd, Dated November 25, 2003.10.10
              7
              Security
                  Agreement between Implant Sciences Corporation and Laurus Master
                  Fund,
                  Ltd. Dated November 25, 2003.10.11
              7
              Common
                  Stock Purchase Warrant for 100,000 shares issued to Laurus Master
                  Fund,
                  Ltd. Dated November 25, 2003.10.12
              8
              Exchange
                  and Venture agreement between Implant Sciences Corporation, CardioTech
                  International, and CorNova, Inc. dated March 5, 2004.10.13
              9
              Form
                  of Securities Purchase Agreement between Implant Sciences and certain
                  investors.10.14
              9
              Form
                  of Warrant dated June, 17, 2004.10.15
              9
              Form
                  of Additional Investors Rights Agreement dated June 17, 2004 between
                  Implant Sciences and certain investors.10.16
              9
              Form
                  of Registration Rights Agreement dated June 17, 2004 between Implant
                  Sciences and certain investors.10.17
              10
              Employment
                  Agreement with Anthony J. Armini, dated June 30, 2004.10.18
              11
              Agreement
                  and Plan of Merger and Reorganization, dated October 13, 2004,
                  by and
                  among the Company, C Acquisition Corp., Core Systems Incorporated
                  and
                  Donald W. Lindsey.10.19
              12
              Securities
                  Purchase Agreements, dated March 4, 2005, by and between the Company
                  and
                  the Purchasers thereunder, with attached schedules.10.20
              12
              Form
                  of Common Stock Purchase Warrant, dated March 4, 2005, by the Company
                  in
                  favor of Pacific Wave Partners Limited.10.21
              12
              Form
                  of Common Stock Purchase Warrant, dated March 4, 2005, by the Company
                  in
                  favor of the Purchasers.10.22
              12
              Form
                  of Additional Investment Right, dated March 4, 2005, by and between
                  the
                  Company in favor of the purchasers.10.23
              12
              Registration
                  Rights Agreement, dated March 4, 2005, by and between the Company
                  and the
                  parties thereto.
  93
 
 10.24
              13
              Stock
                  Purchase Agreement dated March 9, 2005 by and among the Company,
                  Accurel
                  and the Stockholders.10.25
              13
              Form
                  of the Securted Promissory Note dated March 9, 2005 made out by
                  the
                  Company in favor of the Stockholders.10.26
              13
              Note
                  and Security Agreement dated March 9, 2005, by and among the Company,
                  the
                  Stockholders and the Escrow Agent thereunder.10.27
              13
              Holdback
                  and Escrow Agreement dated March 9, 2005, by and among the Company,
                  the
                  Stockholders and the Escrow Agent thereunder.10.28
              14*
              Development,
                  Distribution and Manufacturing Agreement dated March 23, 2005 by
                  and
                  between the Company and Rapiscan Systems, Inc.10.29
              16
              Form
                  of Business Financing Agreement dated June 1, 2005 between the
                  Company and
                  Bridge Bank, N.A.10.30
              16
              Form
                  of Intellectual Property Security Agreement dated June 1, 2005
                  between
                  Implant Sciences Corporation and Bridge Bank, N.A.10.31
              16
              Form
                  of Intellectual Property Security Agreement dated June 1, 2005
                  between C
                  Acquisition Corp. and Bridge Bank, N.A.10.32
              17
              Form
                  of Securities Purchase Agreement, dated as of July 6, 2005, by
                  and between
                  the Company and Laurus Master Fund, Ltd.10.33
              17
              Form
                  of Secured Term Note, dated as of July 6, 2005, by the Company
                  in favor of
                  Laurus Master Fund, Ltd.10.34
              17
              Form
                  of Subsidiary Guaranty, dated as of July 6, 2005, by the Company
                  in favor
                  of Laurus Master Fund, Ltd.10.35
              17
              Form
                  of Common Stock Purchase Warrant, by the Company in favor of Laurus
                  Master
                  Fund, Ltd.10.36
              17
              Form
                  of Funds Escrow Agreement.10.37
              17
              Form
                  of Master Security Agreement.10.38
              19
              Securities
                  Purchase Agreement by and between the Company and Laurus Master
                  Fund,
                  dated September 30, 2005.10.39
              19
              Registration
                  Rights Agreement by and between the Company and Laurus Master Fund,
                  dated
                  September 30, 2005.10.40
              19
              Subsidiary
                  Guaranty dated September 30, 2005.10.41
              19
              Form
                  of Common Stock Purchase Warrant dated September 30,
                  2005.10.42
              19
              Form
                  of Funds Escrow Agreement by and among the Company, Laurus Master
                  Fund and
                  Loeb & Loeb LLP.10.43
              19
              Form
                  of Master Security Agreement by and among the Company, C-Acquisition
                  Corporation, Accurel Systems and Laurus Master Fund, dated September
                  30,
                  2005.10.44
              19
              Form
                  of Stock Pledge Agreement by and between the Company and Laurus
                  Master
                  Fund dated September 30, 2005.10.45
              20
              Form
                  of Common Stock Purchase Warrant, by the Company in favor of Laurus
                  Master
                  Fund, Ltd, dated May 31, 2006.10.46
                10.47
                10.48
                10.49
                10.50
                10.51
              20
                21
                22
                23
                24
                25
              Form
                  of Amendment to Securities Purchase Agreement by and between the
                  Company
                  and Laurus Master Fund dated May 31, 2006.
                2000
                  Incentive and Non-Qualified Stock Option Plan
                2005
                  Incentive Stock Option Plan
                2004
                  Employee Stock Purchase Plan
                Form
                  of Business Financing Agreement with Bridge Bank dated January
                  3, 2007 and
                  Form of Short term note with Laurus Master Fund, Ltd, dated December
                  29,
                  2006.
                Transition
                  Agreement between the Company and Anthony J. Armini dated September
                  27,
                  200721.1
              18
              Subsidiaries
                  of the Company.23.1
              
              Consent
                  of UHY LLP.23.2
              
              Consent
                  of BDO Seidman, LLP.31.1
              
              Certification
                  of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
                  Act of 2002.31.2
              
              Certification
                  of the Chief Financial Officer Pursuant to Section 302 of the
                  Sarbanes-Oxley Act of 2002.32.1
              
              Certification
                  of the Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted
                  Pursuant to Section 906 of the Sarbanes-Oxley Act of
                  2002.32.2
              
              Certification
                  of the Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted
                  Pursuant to Section 906 of the Sarbanes-Oxley Act of
                  2002.
  94
 
 1
              Previously
                  filed in the Registration Statement on Form SB-2 (Registration
                  No.
                  333-64499) filed on September 29, 1998, and is incorporated herein
                  by
                  reference.2
              Previously
                  filed in Amendment No. 1 to the Registration Statement, filed on
                  December
                  21, 1998, and is incorporated herein by reference.3
              Previously
                  filed in Amendment No. 2 to the Registration Statement, filed on
                  February
                  11, 1999, and is incorporated herein by reference.5
              Previously
                  filed in the Annual Report on Form 10 KSB for the fiscal year ended
                  June
                  30, 2002 filed on October 15, 2002 and is incorporated herein by
                  reference.6
              Previously
                  filed in the Annual Report on Form 10 KSB for the fiscal year ended
                  June
                  30, 2003 filed on September 29, 2003 and is incorporated herein
                  by
                  reference.7
              Previously
                  filed on Form 8-K on December 12, 2003, and is incorporated herein
                  by
                  reference.8
              Previously
                  filed on Form 8-K on March 18, 2004, and is incorporated herein
                  by
                  reference.9
              Previously
                  filed on Form S-3 on July 14, 2004, and is incorporated herein
                  by
                  reference.10
              Previously
                  filed in the Annual Report on Form 10-KSB for the fiscal year ended
                  June
                  30, 2004, and is incorporated herein by reference.11
              Previously
                  filed on Form 8-K on October 19, 2004, and is incorporated herein
                  by
                  reference.12
              Previously
                  filed on Form 8-K or Amendment Form 8-K on March 9, 2005 and is
                  incorporated herein by reference.13
              Previously
                  filed on Form 8-K on March 11, 2005 and is incorporated herein
                  by
                  reference.14
              Previously
                  filed on an Amendment to Form 8-K on April 7, 2005 and is incorporated
                  herein by reference.15
              Previously
                  filed with this Registration Statement.16
              Previously
                  filed on Form 8-K on June 13, 2005 and is incorporated herein by
                  reference.17
              Previously
                  filed on Form 8-K on July 14, 2005 and is incorporated herein by
                  reference.18
              Previously
                  filed on Form S-3 on August 4, 2005 and is incorporated herein
                  by
                  reference.19
              Previously
                  filed on Form 8-K on October 5, 2005 and is incorporated herein
                  by
                  reference.20
              Previously
                  filed on Form 8-K on June 6, 2006 and is incorporated herein by
                  reference.21
                22
                23
                24
                25
              Previously
                  filed on Form S-8 on December 12, 2003 and is incorporated herein
                  by
                  reference.
                Previously
                  filed on Form S-8 on October 27, 2006 and is incorporated herein
                  by
                  reference.
                Previously
                  filed on Form S-8 on July 26, 2007 and is incorporated herein by
                  reference.
                Previously
                  filed on Form 8-K on January 5, 2007 and is incorporated herein
                  by
                  reference.
                Previously
                  filed on Form 8-K on October 3, 2007 and is incorporated herein
                  by
                  reference*
              Filed
                  pursuant to a request for confidential
                  treatment.
 
  
 95
 
 **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 CorporationDate:
                    October 15, 2007
                /s/
                    Phillip C.
                    ThomasPhillip
                    C. ThomasPresident,
                    Chief Executive Officer(Principal
                    Executive Officer)
 
 In
          accordance with the Exchange Act,
          this report has been signed below by the following persons on behalf of
          the
          registrant and in the capacities and on the dates indicated, and each of
          the
          undersigned officers and directors of Implant Sciences Corporation hereby
          severally constitutes and appoints Phillip C. Thomas his true and lawful
          attorney-in-fact and agent, with full power to him, to sign for him, in
          his name
          in the capacity indicated below, all amendments to such report on Form
          10-K,
          hereby ratifying and confirming his signature as it may be signed by his
          attorney to such report and any and all amendments thereto.
 
 Date:
                    October 15, 2007
                /s/
                    Phillip C. ThomasPhillip
                    C. ThomasPresident,
                    Chief Executive Officer(Principal
                    Executive Officer)Date:
                    October 15, 2007
                /s/
                    Diane J. Ryan5iane
                    J. RyanVP
                    Finance and CFO(Principal
                    Financial and Accounting Officer)Date:
                    October 15, 2007
                /s/
                    Stephen N. BunkerStephen
                    N. BunkerVice
                    President and Chief Scientist,DirectorDate:  October
                    15, 2007
                /s/
                    Anthony J. ArminiAnthony
                    J. ArminiChairman
                    of the Board of DirectorsDate:
                    October 15,
                /s/
                    Michael SzycherMichael
                    Szycher, DirectorDate:
                    October 15, 2007
                /s/
                    David EisenhaureDavid
                    Eisenhaure, DirectorDate:
                    October 15, 2007
                /s/
                    Michael TurmelleMichael
                    Turmelle, Director
   97