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EX-31.1 - 100630_IMSC FORM 10K_EXHIBIT 31.1 - IMPLANT SCIENCES CORPimsc10k_ex31-1.htm
EX-32.1 - 100630_IMSC FORM 10K_EXHIBIT 32.1 - IMPLANT SCIENCES CORPimsc10k_ex32-1.htm
EX-23.1 - 100630_IMSC FORM 10K_EXHIBIT 23.1 - IMPLANT SCIENCES CORPimsc10k_ex23-1.htm
EX-23.2 - 100630_IMSC FORM 10K_EXHIBIT 23.2 - IMPLANT SCIENCES CORPimsc10k_ex23-2.htm
EX-32.2 - 100630_IMSC FORM 10K_EXHIBIT 32.2 - IMPLANT SCIENCES CORPimsc10k_ex32-2.htm
EX-31.2 - 100630_IMSC FORM 10K_EXHIBIT 31.2 - IMPLANT SCIENCES CORPimsc10k_ex31-2.htm
EX-10.60 - 100630_IMSC FORM 10K_EXHIBIT 10.60 - IMPLANT SCIENCES CORPimsc10k_ex10-60.htm
EX-21 - 100630_IMSC FORM 10K_EXHIBIT 21 - IMPLANT SCIENCES CORPimsc10k_ex21.htm


U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
 
(Mark One)
   
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
   
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2010
o
 
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
   
SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to

 
Commission File No. 001-14949
 
Implant Sciences Corporation
(Name of small business issuer in its charter)
 
Massachusetts
(State or other jurisdiction of
incorporation or organization)
04-2837126
(I.R.S. Employer Identification No.)
600 Research Drive, Wilmington, MA
 (Address of principal executive offices)
01887
(Zip Code)

 
Issuer’s telephone number (978) 752-1700
 
Securities registered under Section 12(b) of the Exchange Act: None
 
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.10 par value per share
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes q  No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.Yes q  No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes q  No x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes q  No x

Indicate by check mark if disclosure of delinquent filers 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.q
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company in Rule 12b-2 of the Act (Check one):
 
q  Large Accelerated Filer                                                                                                           q  Accelerated Filer
 
q  Non-accelerated Filer (do not check if a smaller reporting company)                                                                                                                                x  Smaller reporting company
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes q  No x
 
As of January 31, 2011, 27,894,615 shares of the registrant’s Common Stock were outstanding.  As of December 31, 2009, the last business day of the registrant’s most recent completed second quarter, the aggregate market value of the registrant’s Common Stock held by non-affiliates of the registrant (without admitting that any person whose shares are not included in such calculation is an affiliate) was $8,817,000 based on the last sale price as reported by the Over-The-Counter-Bulletin-Board on such date.
 

 

 
 
 

 

IMPLANT SCIENCES CORPORATION
FORM 10-K
FOR THE YEAR ENDED JUNE 30, 2010

INDEX

PART I
       
Item 1.
 
Description of Business
 
3
Item 1A.
 
Risk Factors
 
11
Item 1B.
 
Unresolved Staff Comments
 
20
Item 2.
 
Description of Properties
 
20
Item 3.
 
Legal Proceedings
 
21
Item 4.
 
Removed and Reserved
 
21
PART II
       
Item 5.
 
Market for Registrant’s Common Equity, Related Stockholder Matters
   and Issuer Purchases of Equity Securities
 
22
Item 6.
 
Selected Financial Data
 
23
Item 7.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
23
Item 7A.
 
Quantitative and Qualitative Disclosures About Market Risk
 
37
Item 8.
 
Financial Statements and Supplementary Data
 
38
Item 9.
 
Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
 
38
Item 9A.
 
Controls and Procedures
 
38
Item 9B.
 
Other Information
 
39
PART III
       
Item 10.
 
Directors, Executive Officers and Corporate Governance
 
40
Item 11.
 
Executive Compensation
 
46
Item 12.
 
Security Ownership of Certain Beneficial Owners and Management
   and Related Stockholder Matters
 
51
Item 13.
 
Certain Relationships and Related Transactions, and Director Independence
 
53
Item 14.
 
Principal Accounting Fees and Services
 
53
PART IV
       
         
Item 15.
 
Exhibits, Financial Statement Schedules
 
55
   
Index to Financial Statements
 
F-1
 

 


 
 
 
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PART I
 
Item 1.
Business
 
 
Cautionary Note Regarding Forward Looking Statements
 
This Annual Report on Form 10-K contains certain statements that are “forward-looking” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Litigation Reform Act”).  These forward looking statements and other information are based on our beliefs as well as assumptions made by us using information currently available.
 
The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “should” and similar expressions, as they relate to us, are intended to identify forward-looking statements.  Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions, and are not guaranties of future performance.  Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected, intended or using other similar expressions.
 
In accordance with the provisions of the Litigation Reform Act, we are making investors aware that such forward-looking statements, because they relate to future events, are by their very nature subject to many important factors that could cause actual results to differ materially from those contemplated by the forward-looking statements contained in this Annual Report on Form 10-K.  Important factors that could cause actual results to differ from our predictions include those discussed under “Risk Factors,” “Management’s Discussion and Analysis” and “Business.”  Although we have sought to identify the most significant risks to our business, we cannot predict whether, or to what extent, any of such risks may be realized, nor can there be any assurance that we have identified all possible issues which we might face.  In addition, assumptions relating to budgeting, marketing, product development 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 us to alter our marketing, capital expenditure or other budgets, which may in turn affect our financial position and results of operations.  For all of these reasons, the reader is cautioned not to place undue reliance on forward-looking statements contained herein, which speak only as of the date hereof.  We assume no responsibility to update any forward-looking statements as a result of new information, future events, or otherwise except as required by law.  We urge readers to review carefully the risk factors described in this Annual Report and in the other documents that we file with the Securities and Exchange Commission.  You can read these documents at www.sec.gov.
 
Where we say “we,” “us,” “our,” “Company” or “Implant Sciences” we mean Implant Sciences Corporation and its subsidiaries.
 
 
General
 
Overview
 
We develop, manufacture and sell sophisticated sensors and systems for the Security, Safety and Defense (“SS&D”) industries.  A variety of technologies are currently used worldwide in security and inspection applications.  In broad terms, the technologies focus on detection in two major categories: (i) the detection of “bulk” contraband, which includes materials that would be visible to the eye, such as weapons, explosives, narcotics and chemical agents; and (ii) the detection of “trace” amounts of contraband, which includes trace particles or vapors of explosives, narcotics and chemical agents.  Technologies used in the detection of “bulk” materials include computed tomography, transmission and backscatter x-ray, metal detection, trace detection and x-ray, gamma-ray, passive millimeter wave, and neutron analysis.  Trace detection techniques used include mass spectrometry, gas chromatography, chemical luminescence, and ion mobility spectrometry.
 
We have developed proprietary technologies used in explosives trace detection (“ETD”) applications and market and sell handheld and benchtop ETD systems that use our proprietary ETD technologies.  Our products are marketed and sold to a growing number of locations domestically and internationally.  These systems are used by private companies and government agencies to screen baggage, cargo, vehicles, other objects and people for the detection of trace amounts of explosives.
 


 
 
 
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History
 
Since our incorporation in August 1984, we have operated as a multi-faceted company engaging in the development of ion-based technologies and providing commercial services and products to the semiconductor, medical device and security industries.  As further discussed in the Business Strategy section below, however, we have recently divested our semiconductor and medical business activities in order to focus on our security business.
 
Semiconductor Business Unit
 
Our business began as a result of the development of our proprietary ion-beam technology and application of this technology in services to the semiconductor industry.  At the outset, our initial business was to provide ion implantation services to the semiconductor industry for surface modification of silicon wafers.  Our services were provided to semiconductor companies, universities and research facilities as an outsource provider of these ion implantation services.  These services were performed at our Massachusetts facility, where we maintained and operated several ion implanters.
 
In November 2008, as part of our strategic initiative to focus on our security business, we sold substantially all of the assets of our wholly owned semiconductor wafer processing subsidiary, C Acquisition Corp., which had operated under the name Core Systems, to Core Systems Incorporated, an entity newly formed by the subsidiary’s general manager and certain other investors, for $3,000,000 plus the assumption of certain liabilities.  For the year ended June 30, 2009, the operations of Core Systems have been recorded in our statements of operations as discontinued operations.
 
In May 2007, as part of our strategic initiative to focus on our security business, we sold substantially all of the assets of our wholly owned semiconductor wafer analytical services subsidiary, Accurel Systems International Corporation, to Evans Analytical Group LLC in exchange for cash of $12,705,000, of which $1,000,000 was placed in escrow.
 
 In February 2008, Evans filed suit against us and against John Traub, a former officer of the Company and of Accurel, requesting rescission of the acquisition agreement, plus damages, based on claims of misrepresentation and fraud.  In March 2008, Evans filed a claims notice with the escrow agent prohibiting release of any portion of the escrowed funds pending resolution of the lawsuit.  On March 27, 2009, we announced the settlement of this litigation and the mutual release by the Company and Evans of all claims related to the sale of Accurel.  In settling this litigation, we agreed to pay Evans damages in the amount of approximately $5,700,000 by releasing to Evans approximately $700,000 that had been held in escrow since the time of the closing and issuing to Evans 1,000,000 shares of Series E Convertible Preferred Stock having an aggregate liquidation preference of $5,000,000.
 
Mr. Traub had demanded that we indemnify him in connection with the Evans litigation. We refused to do so, and our insurer, Carolina Casualty Company, refused to advance Mr. Traub’s litigation expenses. In April 2009, Mr. Traub filed suit for breach of contract and indemnification against us and our insurer, demanding payment of his defense costs and indemnification with respect to the Evans litigation. On June 21, 2010, we resolved the litigation with Evans and Traub, resulting in the cancellation of 1,000,000 shares of Series E Convertible Preferred Stock. Please see more detailed discussions of the Evans matter in Note 26 to our consolidated financial statements.
 
Medical Business Unit
 
We also used our ion beam technology to develop ion implantation and thin film coatings applications for medical devices.  As a result of these technologic advancements, which were in part funded by government research grants and awards, we were able expand our business and provide services and products to the medical industry.  The primary medical related businesses in which we engaged were (i) providing services to medical device companies for surface modification of implantable devices, (ii) the development of brachytherapy products, and (iii) the manufacture and sales of our proprietary radioactive seeds for the treatment of prostate cancer.
 
We provided ion implantation services to modify orthopedic joint implant surfaces, resulting in reduced polyethylene wear and increased implant life, through the second quarter of fiscal 2007.  In the second quarter of fiscal 2007, our primary customer discontinued its product line using our ion implantation services.  Using similar technology, we developed applications for coatings of cardiovascular devices, such as coronary stents.  In May 1999, we received Food and Drug Administration 510(k) clearance to market our radioactive seed for the treatment of prostate cancer.  We began commercial sales of our radioactive seed in fiscal 2001.
 


 
 
 
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In further support of our strategic initiative to focus on our security business, in June 2007, we sold certain of the assets related to our brachytherapy products and divested our prostate seed and medical software businesses and discontinued coatings operations at the end of the 2008 calendar year. During the year ended June 30, 2009 we sold certain assets associated with our medical coatings and ion implantation businesses.  As of June 30, 2009, the assets and liabilities of the Medical Business Unit have been recorded on our balance sheet as held-for-sale.  For the years ended June 30, 2010 and 2009, the operations of the Medical Business Unit have been recorded in our statements of operations as discontinued operations.
 
Security Business Unit
 
Since May 1999, we have been performing research to improve ETD technology, and developing ETD products that can be used for detection of trace amounts of explosives.  At present, we have developed both portable and benchtop systems, which have been marketed and sold both domestically and internationally.  In order to reduce manufacturing costs and be responsive to large quantity orders, we use 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.
 
In April 2008, we acquired all of the capital stock of Ion Metrics, Inc., located in San Diego, California.  Ion Metrics develops mass sensor systems to detect and analyze chemical compounds such as explosives, chemical warfare agents, narcotics, and toxic industrial chemicals for the homeland defense, forensic, environmental, and safety/security markets.  Ion Metrics miniaturized devices and system designs provide high performance and reliability in combination with low manufacturing costs. Ion Metrics operating results have been included in our  statement of operations commencing on April 10, 2008.
 
Industry Overview
 
We believe that the market for security and inspection products will continue to be affected by the threat of terrorist incidents and by new government mandates and appropriations for security and inspection products in the United States and internationally.
 
The September 11, 2001 terrorist attacks on the World Trade Center and the Pentagon using hijacked airliners led to nationwide shifts in transportation and facilities security policies.  Shortly following these attacks, the U.S. Congress passed the Aviation and Transportation Security Act and integrated many U.S. security-related agencies, including the Federal Aviation Administration, into the U.S. Department of Homeland Security (“DHS”).  Under its directive from Congress, the DHS has undertaken numerous initiatives to prevent terrorists from entering the country, hijacking airliners, and obtaining and trafficking in weapons of mass destruction and their components, to secure sensitive U.S. technologies and to identify and screen high-risk cargo containers before they are loaded onto vessels destined for the U.S., among others.  These initiatives, more fully described in the Strategic Border Initiative, the Customs-Trade Partnership Against Terrorism and the U.S. Customs and Border Protection Container Security Initiative, have resulted in an increased demand for security and inspection products both in the United States and other nations.
 
These government-sponsored initiatives have also stimulated security programs in other areas of the world as the U.S initiatives call on other nations to bolster their port security strategies, including acquiring or improving their security and inspection equipment.  As a result, the international market for non-intrusive inspection equipment continues to expand as countries that ship goods directly to the United States are required to improve their security infrastructure.
 
The U.S. Congress recently passed legislation that mandated the inspection of international maritime cargo destined for the United States, domestic civil aviation cargo, and for radiological and nuclear threats in cargo entering the United States.  In addition, following recommendations outlined in the “9/11 Commission Report,” issued by the National Commission on Terrorist Attacks Upon the United States, the screening of all cargo carried on passenger airlines was effective in August 2010.
 
Furthermore, DHS’s Science and Technology Directorate has supported the development of new security inspection technologies and products.  We participate in a number of such research and development efforts, including projects to develop new technologies for improving the accuracy of detection of trace amounts of explosives, narcotics and chemical agents; and improved sampling techniques for the application of trace detection to aviation and cargo screening.  The Science and Technology Directorate has also initiated programs for the development of technologies capable of protecting highways, railways and waterways from terrorist attack.
 


 
 
 
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In addition, the U.S. Department of Defense has also begun to invest more heavily in technologies and services that screen would-be attackers before they are able to harm U.S. and allied forces.
 
Similar initiatives by international organizations such as the European Union have also resulted in a growing worldwide demand for airline, cargo, port and border inspection technologies.  For example, the European Union is expected to issue uniform performance standards for people, cargo, mail and parcel and hold baggage screening systems as well as new directives related specifically to maritime security.  We anticipate that the promulgation of these new standards will establish performance baselines against which we will be able to direct certain of our research and development spending and market our products to customers located in the European Union.
 
As a result of these and other changes, sales of our security products have improved.  Major projects recently installed or currently underway include system installations at airports, ports and border crossings, government and military facilities and other locations, primarily in the international marketplace.  We anticipate that there may be growing demand from governments and commercial enterprises for increasingly sophisticated screening solutions in the future.
 
 
Technology
 
Since May 1999, we have performed research and development in the area of explosives trace detection (“ETD”).  We have developed several proprietary technologies in key areas of ETD which we believe improve the harvesting, collection and detection of trace particles and vapors of explosives substances.  In addition, we are continuing our development efforts to adapt this technology for the detection of narcotics and other chemical agents.  Our intellectual property portfolio contains 17 security-related patents and patents pending:  ten issued United States patents, six United States patents pending, and one licensed patent. We believe that our portfolio of patents and patents pending provides extensive protection in sample harvesting, sample detection and collection.  A key to our past and future success is our ability to innovate and offer differentiation in these areas.
 
We compartmentalize ETD into four major areas: (i) harvest, (ii) transport, (iii) analysis, and (iv) reporting.  These technologies are discussed in detail in the following sections.
 
Harvest - Aerosol Particle Release
 
Tiny particles of explosives and narcotics are “sticky” and may adhere to surfaces.  Particles can be transferred if an object, such as fingers or clothing, comes in contact with a particle.  We have demonstrated that a person touching an explosives material can transfer explosives particles to numerous other objects, leaving a trail of particles behind.
 
Our competitors commonly swipe a surface to be interrogated for explosives particles with cloth or paper.  We believe that this “contact” methodology provides an effective but inconsistent method of harvesting a trace sample as compared to an automated, non-contact collection of the sample.  We have developed a method, which we believe to be more efficient, using an aerosol of fine dry ice particles.  This technique, which is surprisingly inexpensive to use, could increase collection sensitivity substantially and eliminate direct contact with a surface.  Our aerosol technology functions as a very gentle version of “sandblasting” and is safe for almost all surfaces.  Since dry ice sublimes into gas, no residue is left behind, and the aerosol may be used indoors.  We have two patents pending on this methodology.
 
Transport
 
Vortex Sampling
 
Once the trace particle has been released from a surface, it has to be transported to a collection point.  Vortex sampling was the first of our sampling innovations.  We have six patents issued and two patents pending in the area of vortex sampling methodology.
 
Our vortex is similar to a miniature tornado.  A hollow spinning cylinder of air flowing outward surrounds and protects an inner vacuum flowing inward.  It is this vortex sampling technology that enables particles released within the vortex, or blown into it, to be transported with high efficiency to a collection filter.
 


 
 
 
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Long-Life Sample Trap
 
Once particles have been liberated from the surface being interrogated for the presence of trace amounts of explosives, the particles are transported to our innovative trapping filter, which is an ultra-fine stainless steel woven mesh.  The trapping filter has a long usable life, which can span several years, requiring inexpensive, routine maintenance.  We believe the trapping filter provides an innovative solution to the more costly consumables used by several of our competitors engaged in ETD using contact methodology for sampling and detection.
 
Analysis
 
Flash Desorption
 
Flash desorption is an optical method for converting the chemistry of a particle, such as the chemicals composing explosives or narcotics, into a vapor that can be subjected to analyses for the discrimination of chemical properties.  In conventional trace chemical detectors, a sample is slowly warmed in an oven producing diluted vapor with low chemical concentrations.  Optical flash vaporization heats a sample within microseconds, producing a high sample concentration for detection.
 
This method is not appropriate with conventional sample collection methods, such as paper wipes, because the paper is white, and the light from the bright flash reflects off, producing little heating.  However, by using our trapping filter, a very fast detection response can be achieved without loss in sensitivity.  We have two patents issued and one patent pending in the area of flash desorption methodology.  The first product under development to take advantage of our flash desorption technology is our air cargo screening system described under “Products” below.
 
Photonic Ionization
 
The conventional method of ionizing vapors for analysis is to use a radioactive beta source.  While ETD equipment using radioactive sources are simple, effective, and need no electricity in the ionization process, there are important issues involving safety, licensing, regular verification of source integrity, and disposal.  Some markets, such as Japan and Australia, are known to reject instruments with radioactive sources.  We believe that most markets would prefer not to have to address the issues surrounding ETD equipment with radioactive sources.
 
We have developed two types of photonic, non-radioactive ion sources for our instruments for applications requiring either the ionization of positive ions or negative ions.  These ion sources may be found individually or in combination within our products, depending on the application for which the ETD equipment is to be used.  We have two patents issued and one patent pending in the area of photonic ionization.
 
Reporting
 
Reporting is that portion of the cycle that displays and stores information generated during the analysis phase.  It is this information a system operator sees and indicates if an alarm condition exists or if the test is negative.  Information can be displayed in both graphical and tabular formats.  The reporting also indicates when the instrument is ready for the next sample as well as displaying built-in system diagnostics.
 
 
Intellectual Property
 
It is our policy to protect our proprietary position by, among other methods, filing United States patent applications.  Our intellectual portfolio contains seventeen security-related patents and patents pending:  ten patents have been issued and are active, six patents are pending and we license one patent.  The ten issued patents expire in the years 2022 through 2030.  We believe our patent portfolio provides extensive protection.  We also rely on unpatented proprietary technology, trade secrets and know-how.
 
 
Manufacturing
 
We manufacture our security products primarily through a sole source contract manufacturer located locally in Worcester, Massachusetts.  We believe our strategy to outsource manufacturing reduces manufacturing costs, improves scheduling flexibility, and allows us to focus our internal resources and management on product development, marketing, sales and distribution.  We also maintain an internal production group at our corporate headquarters in Wilmington, Massachusetts, which is responsible for pre-production logistics, oversight of contract manufacturing, quality control and inventory management.
 


 
 
 
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Products
 
We have developed several explosives detection systems designed for use in aviation and transportation security, high threat facilities and infrastructure, military installations, customs and border protection, and mail and cargo screening.  The systems use our proprietary Quantum SnifferTM technologies, including a photon-based, non-radioactive ion source in combination with ion mobility spectrometry, a classic detection tool sensitive to the unique speeds with which ions of various substances move through the air (“IMS”) to electronically detect minute quantities of explosives vapor and particles.
 
Current Products
 
Quantum SnifferTM QS-H150 Portable Explosives Detector
 
The Quantum Sniffer QS-H150 Portable Explosives Detector employs a patented vortex collector for the simultaneous detection of explosives particulates and vapors with or without physical contact and in real-time.  We believe that our advanced QS-H150 is more sensitive than other detection devices.  The QS-H150 can detect vapors and nanogram quantities of explosives particulates for most explosives substances considered to be threats.  Such substances include, but are not limited to, military and commercial explosives, improvised and homemade explosives, and propellants and taggants.
 
The QS-H150 has automatic and continuous self-calibration.  It monitors its environment, senses changes that would affect its accuracy, and re-calibrates accordingly.  The system requires no user intervention and no calibration consumables.  The detection process begins with the collection of a sample with our patented vortex collector.  After collection, the sample is ionized photonically and analyzed using IMS technology.  The presence of a threat substance is indicated by visible and audible alarms.  The threat substance is then identified and displayed on the integrated LCD screen.
 
When detecting a threat substance, the QS-H150 rapidly alarms.  This real-time detection limits equipment contamination and allows for fast clear-down.  Operation and maintenance are cost-effective.  Since there is no requirement for dopants, calibration consumables or verification consumables, the overall cost of consumables are minimized.  Routine maintenance consists only of care and cleaning using common supplies, and desiccant replacement as required.  No radioactive material is used in the QS-H150, so there are no associated certifications, licenses, inspections, or end-of-life disposal issues.
 
Quantum SnifferTM QS-BTS Benchtop Explosives Detector
 
The two part QS-BTS systems consist of our QS-H150 Portable Explosives Detector, along with a base unit which contains a monitor, printer and power supply.  The QS-BTS functions as a benchtop system with the added capability of functioning as a portable, hand-held trace explosives detector. Optionally, and at any time, the base unit  may be connected for convenient access to spectrogram display and analysis tools, administrative tools, and diagnostics.
 
Products Under Development
 
Quantum SnifferTM QS-H300 Air Cargo Screening System
 
We are developing a hand sampler detector that utilizes our proprietary jetted vortex collector for non-contact collection of trace particulate materials.  We believe the hand sampler, which will be a compact, lightweight device, could significantly improve explosives detection capabilities while also being very user friendly.  Our non-contact method could prove to be more effective than traditional contact sample collection methods, and at a much lower cost to users.  This improved sampling process has applicability for use in detecting trace amounts of explosives found on a wide range of objects such as carry-on luggage, parcels, packages and cargo.  In addition, multiple handheld sampling units could be systematically deployed in concert with a centralized trace explosives detection system to improve efficiency and increase the number of articles screened.  We believe this product could usher in a new way of thinking about how cargo and other items can be properly examined in a cost-effective and user-friendly manner.  We introduced the QS-H300 at the AVSEC 2008 exhibition in Seoul, South Korea in November 2008. Further development of the QS-H300 has been delayed, however, as we focus our efforts on increasing revenues from sales of the QS-H150 portable explosives detector.
 


 
 
 
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Quantum SnifferTM QS-B200 Benchtop Explosives Detector
 
The QS-B200 Benchtop Explosives Detector, currently under development, uses dual IMS with non-radioactive ionization for the detection and identification of a wide range of military, commercial, and improvised explosives.  The QS-B200 has automatic and continuous self-calibration.  It monitors its environment, senses changes that would affect its accuracy, and re-calibrates accordingly.  For detection, the sample is collected with a standard trap, ionized, and analyzed via IMS.  The presence of a threat is indicated by visible and audible alarms, and the substance is identified and displayed on the integrated touch screen display.  Users may save data locally, print via a built-in thermal printer, or send data through standard interfaces such as USB, LAN, etc.  Multi-level password-protected data security is standard.  We believe that the operation and maintenance of the QS-B200 are extremely cost-effective. Routine maintenance consists only of care and cleaning using common supplies, and desiccant replacement as required.  No radioactive material is used in the QS-B200, so there are no associated certifications, licenses, inspections, or end-of-life disposal issues.
 
Quantum Sniffer TM QS-Hx Portable Explosives Detector
 
We are developing a next generation hand held detector that will use dual IMS non-radioactive ionization for the detection and identification of a wide range of military, commercial and improvised explosives, as well as narcotics. The QS-Hx will have automatic and continuous self-calibration, multi-level password-protected data security and will include a data management interface with data export to a network for recordkeeping, providing a link with the central command centers and logistics systems used by major carriers.
 
Miniature Mass Spectrometer
 
We initially developed our own proprietary ion mobility spectrometer (“IMS”).  We believe that as market demand grows for greater precision of substance identification and the list of substances to be detected increases, more advanced detectors will be required.
 
Our acquisition of Ion Metrics enabled us to obtain miniaturized quadrupole mass spectrometry (“QMS”) detector technology.  The QMS detector is roughly the size of an AA battery and has low manufacturing costs.  When used in conjunction with an IMS, the QMS detector senses the molecular weight of the chemical species resulting in an “orthogonal” detection method in which a more fundamental characteristic of a substance is measured.  We believe that, because it is unlikely that two substances would share the same mass and the same ion mobility in air, QMS detector technology improves the accuracy of detection and minimizes false alarms.  We are currently developing interfaces for integrating the QMS detector into our future products.
 
Hyphenated Detectors
 
Depending on the application and the number of “interfering” background chemicals, it may be necessary to incorporate additional “orthogonal” detection methods.  The combination of multiple sensors is commonly known as hyphenated systems.  By measuring different properties of the same species, interferents are separated from target species for a deterministic detection and identification and have minimum rates of false alarms. The combination of these sensors in series is commonly known as employing “hyphenated” detection methods.  A hyphenated system is one in which a sequence of different types of detectors all must agree that an alarm has occurred before a valid alarm is declared.
 
We are currently developing hyphenated systems employing conventional ion mobility, differential mobility and mass spectrometry for the DHS.
 
We believe detection systems incorporating hyphenated detection methods could accelerate the expansion of our product line to more effectively address the needs of the security, safety and defense sector, as well as accelerate our entry into the narcotics, chemical warfare, biological warfare and toxic industrial chemical detection marketplaces.  Combining new technologies with our other innovative products could enhance our competitive position while improving sales volumes and product margins in the future. We expect hyphenated systems to appear in our future product offerings.


 
 
 
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Marketing and Sales
 
We market and sell our products through direct sales and marketing staff located in the United States, in addition to a global network of independent and specialized sales representatives and distributors.  This sales staff is supported by a sales organization located primarily in the United States, as well as a global network of independent distributors.
 
We have not experienced, and do not expect to experience, in any material respect, seasonality in sales of our products.
 
 
Contracts and Material Relationships
 
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 Department of Defense, DHS 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 Department of Defense, the National Science Foundation, the National Aeronautics and Space Administration, the Environmental Protection Agency and the DHS.
Competition
 
In the trace explosives detection industry, Morpho Detection, Inc. and Smiths Detection, Inc. 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.  We believe our technology differs from the competition in that we do not have a radioactive ion source, we have lower operating costs, and can perform “real time” detection.  We believe our patented technology provides our device with greater operating advantages and fewer regulatory restrictions.
 
 
Research and Development
 
Our technical staff consists of 8 scientists and engineers, one of whom holds a Ph.D., and two of whom hold Masters degrees.  All of our existing and planned products rely on proprietary technologies developed in our research and development laboratories.  Our research and development efforts are generally self-funded, but may also be 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 any technology developed pursuant to the program, subject to the retention by the U.S. government of a royalty-free license to use the technology.  We have obtained over $20 million in U.S. government grants and contracts over the past 20 years.
 
We spent approximately $1,873,000 and $2,136,000 on internally funded research and development in the fiscal years ended June 30, 2010 and 2009, respectively.
 
 
Government Regulation and Environmental Compliance
 
From time to time, legislation is drafted and introduced in Congress that could significantly change the statutory provisions governing the approval, manufacturing and marketing of security products.
 
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 U.S. Environmental Protection Agency and/or its state counterparts. Our costs to comply with these requirements have not been material. We are not aware of any specific environmental liabilities to which we are likely to be subject.  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.
 
 
Employees
 
As of June 30, 2010, we had 28 full-time employees at our Massachusetts facility and one full-time employee in California.
 
None of these employees are covered by a collective bargaining agreement, and management considers its relations with its employees to be good.
 


 
 
 
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Geographic Areas
 
Our revenues are derived from both domestic and international sales.  During the fiscal year ended June 30, 2010, foreign sales represented 85% of total revenue with one customer from China representing 45% of our revenue.  For the fiscal year ended June 30, 2009, foreign sales represented 82% of total revenue with one customer from China representing 48% of our revenue.
 
Item 1A.
Risk Factors
 
An investment in our common stock involves a high degree of risk. Investors should carefully consider the following risk factors in evaluating our Company and our business.  If any of these risks, or other risks not presently known to us or that we currently believe are not significant, develops into an actual event, then our business, financial condition and results of operations could be adversely affected.  If that happens, the market price of our common stock could decline.
 
Risks Related to our Liquidity
 
We will require additional capital to fund operations and continue the development, commercialization and marketing of our product.  Our failure to raise capital could have a material adverse effect on our business.
 
Management continually evaluates plans to reduce its operating expenses, increase sales and increase its cash flow from operations.  Despite our current sales, expense and cash flow projections and the cash available from our line of credit with DMRJ Group LLC, we will require additional capital in the third quarter of fiscal 2011 to fund operations and continue the development, commercialization and marketing of our products. Our failure to achieve our projections and/or obtain sufficient additional capital on acceptable terms would have a material adverse effect on our liquidity and operations and could require us to file for protection under bankruptcy laws.
 
We will be required to repay our borrowings from DMRJ Group LLC  on March 31, 2011.
 
We will be required to repay all of our borrowings from DMRJ Group LLC on March 31, 2011.  Our obligations to DMRJ are secured by a security interest in substantially all of our assets.  As of June 30, 2010, the outstanding balances due to DMRJ under a senior secured convertible promissory note, a second secured promissory note and a revolving credit facility was $3,920,000, $1,000,000 and $8,143,000, respectively.  As of December 31, 2010 the outstanding balances due to DMRJ under that senior secured convertible promissory note, a second secured promissory note and a revolving credit facility were $3,760,000, $1,000,000 and $10,994,000, respectively.  If we are unable to repay these amounts as required, refinance our obligations to DMRJ, or negotiate extensions of these obligations, DMRJ may seize our assets and we may be forced to curtail or discontinue operations entirely.
 
 We have received a qualified audit opinion on our ability to continue as a going concern.
 
The audit report issued by our independent registered public accounting firm issued on our audited financial statements for the fiscal year ended June 30, 2010 contains a qualification regarding our ability to continue as a going concern.  This qualification indicates there is substantial doubt on the part of our independent registered public accounting firm as to our ability to continue as a going concern due to the risk that we may not have sufficient cash and liquid assets at June 30, 2010, 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 our accounting firm will not qualify its opinion in the future.
 


 
 
 
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Risks Related to Our Business
 
We have incurred substantial operating losses and we may never be profitable.  There can be no assurance that our revenue will be maintained at the current level or increase in the future.
 
During the fiscal years ended June 30, 2010 and 2009, we had revenues of approximately $3,474,000 and $8,737,000, respectively.  During the fiscal years ended June 30, 2010 and 2009, we had losses from continuing operations of approximately $15,399,000 and $13,559,000, respectively.  During the fiscal years ended June 30, 2010 and 2009, we had net losses of approximately $15,523,000 and $12,751,000, respectively.  There is a risk that we will never be profitable.  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 we will likely incur losses over the next several quarters.  Our accumulated deficit as of June 30, 2010 and 2009 was approximately $89,332,000 and $72,678,000, respectively.  Our ability to generate sufficient revenues to achieve profits will depend on a variety of factors, many of which are outside our control, including:
 
·  
the size of the markets we address;
 
·  
the existence of competition and other solutions to the problems we address;
 
·  
the extent of patent and intellectual property protection afforded to our products;
 
·  
the cost and availability of raw material and intermediate component supplies;
 
·  
changes in governmental (including foreign governmental) initiatives and requirements;
 
·  
changes in domestic and foreign regulatory requirements; and
 
·  
the costs associated with equipment development, repair and maintenance; and our ability to manufacture and deliver products at prices that exceed our costs.
 
Our operating results have fluctuated in the past from quarter to quarter and are likely to fluctuate significantly in the future due to a variety of factors, many of which are beyond our control, including:
 
·  
changing demand for our products and services;
 
·  
the timing of actual customer orders and requests for product shipment and the accuracy of our forecasts of future production requirements;
 
·  
the reduction, rescheduling or cancellation of product orders by customers;
 
·  
difficulties in forecasting demand for our products and the planning and managing of inventory levels;
 
·  
the introduction and market acceptance of our new products and changes in demand for our existing products;
 
·  
changes in the relative portion of our revenue represented by our various products, services and customers, including the relative mix of our business across our target markets;
 
·  
changes in competitive or economic conditions generally or in our markets;
 
·  
competitive pressures on selling prices;
 
·  
the amount and timing of costs associated with product warranties and returns;
 
·  
changes in availability or costs of materials, components or supplies;
 
·  
changes in our product distribution channels and the timeliness of receipt of distributor resale information;
 
·  
the amount and timing of investments in research and development;
 
·  
difficulties in integrating acquired assets and businesses into our operations; and
 
·  
charges to earnings resulting from the application of the purchase method of accounting following acquisitions.
 
·  
expectation that we will be required to record recurring non-cash adjustments to earnings in subsequent reporting periods, as a result of changes in fair value of the warrant derivative liability and the note conversion liability which will be subject to, among other factors, changes from time to time in the price of our common stock.
 


 
 
 
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A substantial portion of our revenue in any quarter historically has been derived from orders booked and shipped in the same 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.
 
As a result of these factors, many of which are difficult to control or predict, as well as the other risk factors discussed in this Annual Report, we may experience material adverse fluctuations in our future operating results on a quarterly or annual basis.
 
Our markets are subject to technological change and our success depends on our ability to develop and introduce new products.
 
The market for our security products is characterized by:
 
·  
changing technologies;
 
·  
changing customer needs;
 
·  
frequent new product introductions and enhancements;
 
·  
increased integration with other functions; and
 
·  
product obsolescence.
 
Our success will be dependent in part on the design and development of new products.  To develop new products and designs for our security market, we must develop, gain access to and use leading technologies in a cost-effective and timely manner and continue to expand our technical and design expertise.  The product development process is time-consuming and costly, and there can be no assurance that product development will be successfully completed, that necessary regulatory clearances or approvals will be granted on a timely basis, or at all, or that the potential products will achieve market acceptance.  Our failure to develop, obtain necessary regulatory clearances or approvals for, or successfully market potential new products could have a material adverse effect on our business, financial condition and results of operations.
 
Economic, political and other risks associated with international sales and operations could adversely affect our sales.
 
Our business is subject to risks associated with doing business internationally. During the fiscal year ended June 30, 2010, foreign sales represented 85% of total revenue with one customer from China representing 45% of our revenue.  For the fiscal year ended June 30, 2009, foreign sales represented 82% of total revenue with one customer from China representing 48% of our revenue.  We anticipate that revenues from international operations will continue to represent a substantial portion of our total revenue. Accordingly, our future results could be harmed by a variety of factors, including:

·  
changes in foreign currency exchange rates;
 
·  
changes in a country’s or region’s political or economic conditions, particularly in developing or emerging markets;
 
·  
potentially longer payment cycles of foreign customers and difficulty of collecting receivables in foreign jurisdictions;
 
·  
trade protection measures and import or export licensing requirements;
 
·  
differing legal and court systems;
 
·  
differing tax laws and changes in those laws;
 
·  
differing protection of intellectual property and changes in that protection; and
 
·  
different regulatory requirements and changes in those requirements.
 


 
 
 
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Our explosives detection products and technologies may not be accepted by government agencies or commercial consumers of security products which could harm our future financial performance.
 
There can be no assurance that our explosives detection systems will achieve wide acceptance by government agencies, commercial consumers of security products, 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.  Our failure to develop a commercial product to compete successfully with respect to throughput, the ability to scan personnel, baggage and other cargo, and portability could delay, limit or prevent market acceptance.  Moreover, the market for explosives detection systems, especially trace detection, 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 attacks to be substantial or that governmental agencies and private-industry 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 that currently available products, or products under development for commercialization, will be able to achieve market penetration, revenue growth or profitability.
 
If we cannot obtain the additional capital required to fund our operations on favorable terms, or at all, we may have to delay or reconsider our growth strategy.
 
Our growth strategy may require additional capital for, among other purposes, completing acquisitions of companies and customers’ product lines and manufacturing assets, integrating acquired companies and assets, acquiring new equipment and maintaining the condition of existing equipment.  If cash generated internally is insufficient to fund capital requirements, or if we desire to make additional acquisitions, we will require additional debt or equity financing.  Adequate financing may not be available or, if available, may not be available on terms satisfactory to us.  If we raise additional capital by issuing equity or convertible debt securities, the additional securities will dilute the share ownership of our existing investors.  In addition, we may grant future investors rights that are superior to those of our existing investors.  If we fail to obtain sufficient additional capital in the future, we could be forced to curtail our growth strategy by reducing or delaying capital expenditures and acquisitions, selling assets or restructuring or refinancing our indebtedness.
 
We depend on outside suppliers and subcontractors, and our production and reputation could be harmed if they are unable to meet our volume and quality requirements and alternative sources are not available.
 
We have various “sole source” suppliers who supply key components for our products.  Our outside suppliers may fail to develop and supply us with products and components on a timely basis, or may supply us with products and components that do not meet our quality, quantity or cost requirements.  If any of these problems occur, we may be unable to obtain substitute sources of these products and components on a timely basis or on terms acceptable to us, which could harm our ability to manufacture our own products and components profitably or on time, and to ship products to customers on time and generate revenues.  In addition, if the processes that our suppliers use to manufacture products and components are proprietary, we may be unable to obtain comparable components from alternative suppliers.
 
We depend on a contract manufacturer, and our production and products could be harmed if it is unable or unwilling to meet our volume and quality requirements and alternative sources are not available.
 
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.  From time to time in fiscal 2010, this manufacturer has limited the number of detectors it would manufacture due to our inability to pay for the detectors on a timely basis.  The refusal to manufacture detectors for a substantial period, or the loss of our contract manufacturer altogether, could significantly disrupt production as well as increase the cost of production, thereby increasing the prices of our products.  These changes could have a material adverse effect on our business and results of operations.
 


 
 
 
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We may not be able to protect our intellectual property rights adequately.
 
Our ability to compete is affected by our ability to protect our intellectual property rights.  We rely on a combination of patents, trademarks, copyrights, trade secrets, confidentiality procedures and non-disclosure and licensing arrangements to protect our intellectual property rights.  Despite these efforts, we cannot be certain that the steps we take to protect our proprietary information will be adequate to prevent misappropriation of our technology, or that our competitors will not independently develop technology that is substantially similar or superior to our technology.  More specifically, we cannot assure you that any future applications will be approved, or that any issued patents will provide us with competitive advantages or will not be challenged by third parties.  Nor can we assure you that, if challenged, our patents will be found to be valid or enforceable, or that the patents of others will not have an adverse effect on our ability to do business.  Furthermore, others may independently develop similar products or processes, duplicate our products or processes or design their products around any patents that may be issued to us.
 
Our success depends on our ability to obtain new patents and operate without infringing on the proprietary rights of others.
 
Although we have ten United States patents issued and six United States patent applications pending for our explosives detection 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 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.
 
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.  Any litigation or proceedings relating to the intellectual property rights of any parties, whether or not determined in our favor or settled by us, is costly and may divert the efforts and attention of our management and technical personnel.  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.  Accordingly, challenges to our intellectual property, whether or not ultimately successful, could have a material adverse effect on our business and results of operations.
 
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.
 


 
 
 
-15-

 


Our future success depends on the continued service of management, engineering and sales personnel and our ability to identify, hire and retain additional personnel.
 
Our success depends, to a significant extent, upon the efforts and abilities of members of senior management.  The loss of the services of one or more of our senior management or other key employees could adversely affect our business.  We do not maintain key person life insurance on any of our officers, employees or consultants.
 
There is intense competition for qualified employees in the security industry, particularly for highly skilled design, applications, engineering and sales people.  We may not be able to continue to attract and retain technologists, managers, or other qualified personnel necessary for the development of our business or to replace qualified individuals who could leave us at any time in the future.  Our anticipated growth is expected to place increased demands on our resources, and will likely require the addition of new management and engineering staff as well as the development of additional expertise by existing management employees.  If we lose the services of or fail to recruit engineers or other technical and management personnel, our business could be harmed.
 
Periods of rapid growth and expansion could place a significant strain on our resources, including our employee base.
 
To manage our possible future growth effectively, we will be required to continue to improve our operational, financial and management systems.  In doing so, we will periodically implement new software and other systems that will affect our internal operations regionally or globally.
 
Future growth would also require us to successfully hire, train, motivate and manage our employees.  In addition, our continued growth and the evolution of our business plan will require significant additional management, technical and administrative resources.  We may not be able to effectively manage the growth and evolution of our current business.
 
We are exposed to product liability claims that could place a substantial financial burden on us if we are sued.
 
The development and sale of explosives detection products entails an inherent risk of product liability.  For example, if our products fail to adequately detect explosives, if we are unable to successfully train technicians to properly use our products, or if the market determines or concludes that any of our products are not safe or effective for any reason, we may be exposed to product liability claims.  We currently carry product liability insurance.  No assurances can be given, however, that our product liability insurance will be adequate to pay any claims that might arise.  A product liability claim, whether meritorious or not, could be time-consuming, distracting and expensive to defend, could be harmful to our reputation, could result in a diversion of management and financial resources away from our primary business and could result in product recalls. In any such case, there could be a material adverse effect on our business and results of operations and our business could fail.
 
We use hazardous materials in our research and manufacturing activities.  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.
 


 
 
 
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We have identified a material weakness in our internal control over financial reporting that will result in the restatement of our condensed consolidated financial statements included in our Quarterly Reports on Form 10-Q for the fiscal quarters ended September 30, 2009, December 31, 2009 and March 31, 2010.  This material weakness could cause investors to 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 by management on the company’s internal controls 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 the company’s internal controls over financial reporting.  On October 14, 2010, the Audit Committee of our Board of Directors, in consultation with our management,determined that the condensed consolidated financial statements included in our Quarterly Reports on Form 10-Q for the fiscal quarters ended September 30, 2009, December 31, 2009 and March 31, 2010, should no longer be relied on due to issues raised by our independent accountants, Marcum LLP, regarding errors in our adoption of Accounting Standards Codification 815 “Derivatives and Hedging” related to the non-cash accounting treatment of financial instruments which are not deemed to be indexed to our common stock. Further, we are restating the aforementioned quarters to record, as of July 1, 2009 and August 31, 2009, the commitment dates of our Series F Convertible Preferred Stock, the deemed dividend resulting from the beneficial conversion feature contained in the Series F Convertible Preferred Stock. Our management identified a deficiency in respect of our internal controls over financial reporting, specifically in our controls over the adoption of Accounting Standards Codification (“ASC”) 815-40-15 - “Derivatives and Hedging.” related to the non-cash accounting treatment of financial instruments which are not deemed to be indexed to the company’s common, that constitutes a material weakness. If we fail to implement the 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.
 
Under current rules, we are required to report on the effectiveness of our internal controls for the year ended June 30, 2010.
 
Risks Related to Competition
 
We may not be able to compete effectively against existing or new competitors.
 
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.  Certain of our competitors may have advantages 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.  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.
 


 
 
 
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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.
 
We may face pricing pressures that could prevent us from maintaining the prices of our products.
 
The sales process for our security products is typically a result of a request for quotations or tenders which are subjected to significant and time-consuming scrutiny prior to the determination of an award.  In addition, we face aggressive cost-containment pressures from governmental agencies and the bidding process commonly involves several competitors, many of whom have greater financial and other resources that may enable them to submit bids at prices which might be significantly lower than the prices we may be able to offer.  There can be no assurances that we will be able to maintain current prices in the face of continuing pricing pressures.  Over time, the average price for our products may decline as the markets for these products become more competitive.  Any material reduction in product prices could negatively affect our gross margin, necessitating a corresponding increase in unit sales to maintain any given level of sales.
 
Risks Related to Our Securities
 
The delisting of our common stock by the NYSE Amex has limited our stock’s liquidity and could substantially impair our ability to raise capital.
 
Our common stock was delisted by the NYSE Amex LLC effective in June 2009 as result of our failure to comply with certain continued listing requirements.  Our common stock began trading on the Over-The-Counter-Bulletin-Board in May 2009 and currently trades under the symbol “IMSC”. We believe the delisting has limited our stock’s liquidity and could substantially impair our ability to raise capital.
 
Our stock price is volatile.
 
The market price of our common stock has fluctuated significantly to date.  In the past fiscal year, our stock price ranged from $0.03 to $0.73.  The market price of our common stock may also fluctuate significantly in the future due to:
 
·  
variations in our actual or expected quarterly operating results;
 
·  
announcements or introductions of new products;
 
·  
technological innovations by our competitors or development setbacks by us;
 
·  
the commencement or adverse outcome of litigation;
 
·  
changes in analysts’ estimates of our performance or changes in analysts’ forecasts regarding our industry, competitors or customers;
 
·  
announcements of acquisitions or acquisition transactions; or
 
·  
general economic and market conditions.
 
In addition, the stock market in recent years has experienced extreme price and volume fluctuations that have affected the market prices of many security product companies.  These fluctuations have often been unrelated or disproportionate to the operating performance of companies in our industry, and could harm the market price of our common stock.
 


 
 
 
-18-

 


Additional authorized shares of our common stock and preferred stock available for issuance may adversely affect the market.
 
We are authorized to issue 50,000,000 shares of our common stock. In June 2010, our shareholders approved a proposal to increase the total number of shares of common stock we are authorized to issue to 200,000,000, but we have intentionally delayed the filing of Articles of Amendment to our Restated Articles of Organization with the Commonwealth of Massachusetts to effect that increase.  As of June 30, 2010, there were 24,624,195 shares of common stock issued and outstanding.  However, the total number of shares of our common stock issued and outstanding does not include shares reserved in anticipation of the exercise of options, warrants, convertible debt instruments and convertible preferred stock. As of June 30, 2010, we had outstanding stock options and warrants to purchase approximately 6,301,000 shares of our common stock, the exercise price of which range between $0.08 per share to $12.45 per share, and we have reserved shares of our common stock for issuance in connection with the potential exercise of these instruments.  As of June 30, 2010, the outstanding balance due under the senior secured convertible promissory notes and the convertible promissory note was $3,920,000 and $100,000, respectively, both of which are convertible into shares of our common stock at $0.08 per share. To the extent such options, warrants or additional investment rights are exercised the holders of our common stock will experience further dilution.  Stockholders will also experience dilution upon the exercise of options granted under our stock option plans.  In addition, in the event that any future financing or consideration for a future acquisition should be in the form of, be convertible into or exchangeable for, equity securities investors will experience additional dilution.
 
The exercise of the outstanding options and warrants and the conversion of convertible debt instruments will reduce the percentage of common stock held by our current stockholders.  Further, the terms on which we could obtain additional capital during the life of the derivative securities may be adversely affected, and it should be expected that the holders of the derivative securities would exercise them at a time when we would be able to obtain equity capital on terms more favorable than those provided for by such derivative securities.  As a result, any issuance of additional shares of common stock may cause our current stockholders to suffer significant dilution which may adversely affect the market.
 
In addition, we are authorized to issue 5,000,000 shares of preferred stock, the terms of which may be fixed by our Board of Directors, of which 1,646,663 shares of Series F Convertible Preferred Stock were issued and outstanding as of June 30, 2010.  All of the shares of Series F Preferred Stock is held by our lender, DMRJ Group LLC, and is convertible into 25% of our common stock, calculated on a fully diluted basis.
 
While we have no present plans to issue any additional shares of preferred stock, our Board of Directors has the authority, without stockholder approval, to create and issue one or more series of such preferred stock and to determine the voting, dividend and other rights of holders of such preferred stock.  The issuance of any of such series of preferred stock may have an adverse effect on the holders of common stock and could make a takeover of our company more difficult.
 
Shares eligible for future sale may adversely affect the market.
 
From time to time, certain of our stockholders who acquired their shares directly from our company in privately negotiated transactions 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 effective registration statements under the Securities Act of 1933 and under Rule 144, promulgated under the Securities Act.  In general, pursuant to Rule 144, a stockholder (or stockholders whose shares are aggregated) who has satisfied a six-month 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 one-year holding period.  Any substantial sale of our common stock pursuant to Rule 144 or pursuant to any resale registration statement may have material adverse effect on the market price of our securities.
 


 
 
 
-19-

 


There are limitations on director and officer liability which may limit our stockholders’ rights to recover for breaches of fiduciary duty.
 
As permitted by Massachusetts law, our Restated Articles of Organization, as amended, limit the liability of our directors for monetary damages for breach of a director's fiduciary duties except in certain instances.  As a result of these limitations and Massachusetts law, stockholders may have limited rights to recover against directors for breaches of their fiduciary duties.  In addition, our bylaws provide that we will indemnify our directors, officers, employees and agents if such persons acted in good faith and reasoned that their conduct was in our best interest.
 
The anti-takeover provisions of our Restated Articles of Organization and Massachusetts 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.  Of those 5,000,000 shares, 1,646,663 shares of Series F Convertible Preferred Stock were issued and outstanding as of June 30, 2010.  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 we have issued to date and which 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.  Massachusetts law may also discourage, delay or prevent someone from acquiring or merging with us.
 
We have never paid dividends on our common stock and we do not anticipate paying any cash dividends in the foreseeable future.
 
We have paid no cash dividends on our common stock to date and we currently intend to retain our future earnings, if any, to fund the development and growth of our business.  In addition, our agreements with lenders prohibit the payment of cash dividends.  As a result, capital appreciation, if any, of our common stock will be shareholders’ sole source of gain for the foreseeable future.
 
Item 1B.
Unresolved Staff Comments
 
Not Applicable.
 
Item 2.
Description of Properties
 
We operate out of two separate locations.  Our corporate offices are located in an approximately 23,000 square foot leased facility in Wilmington, Massachusetts.  In addition to our corporate offices, this facility houses research and development, sales and marketing, and production.  Our current lease expires in January 2015.  We lease approximately 2,000 square feet of research and office space in San Diego, California, under a lease expiring in March 2013.
 


 
 
 
-20-

 


Item 3.
Legal Proceedings
 
In May 2007, we sold substantially all of the assets of our wholly owned semiconductor wafer analytical services subsidiary, Accurel Systems International Corporation, to Evans Analytical Group LLC. In February 2008, Evans filed suit against us and against John Traub, a former officer of the Company and of Accurel, requesting rescission of the acquisition agreement, plus damages, based on claims of misrepresentation and fraud.  In March 2008, Evans filed a claims notice with the escrow agent prohibiting release of any portion of the escrowed funds pending resolution of the lawsuit.  On March 27, 2009, we announced the settlement of this litigation and the mutual release by us and Evans of all claims related to the sale of Accurel.  In settling this litigation, we agreed to pay Evans damages in the amount of approximately $5,700,000 by releasing to Evans approximately $700,000 that had been held in escrow since the time of the closing and issuing to Evans 1,000,000 shares of Series E Convertible Preferred Stock having an aggregate liquidation preference of $5,000,000.
 
Mr. Traub had demanded that we indemnify him in connection with the Evans litigation. We refused to do so, and our insurer, Carolina Casualty Company, refused to advance Mr. Traub’s litigation expenses. In April 2009, Mr. Traub filed a complaint in the California Superior Court, Santa Clara County, for breach of contract and indemnification against us and our insurer, demanding payment of his defense costs and indemnification with respect to the Evans litigation.  On June 21, 2010, we resolved the litigation with Evans and Traub, resulting in the cancellation of 1,000,000 shares of Series E Convertible Preferred Stock and we have recorded the $5,000,000 benefit in operating expenses (see Note 18).
 
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. We are not a party to any other legal proceedings, other than ordinary routine litigation incidental to our business, which we believe will not have a material affect on our business, assets or results of operations.
 
Item 4.
Removed and Reserved
 
 


 
 
 
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PART II
 
Item 5.
Market Information for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Our common stock traded on the NYSE Amex LLC (formerly, the American Stock Exchange) under the symbol “IMX” until June 22, 2009 and was delisted by the NYSE Amex on September 22, 2009. Since May 4, 2009, our common stock has traded on the Over-the-Counter Bulletin Board and currently trades under the symbol “IMSC.”  The following table sets forth the high and low bid quotations for our common stock for each of the last two fiscal years, as reported on the American Stock Exchange and the Over-the-Counter Bulletin Board. Quotations from the Over-the-Counter Bulletin Board reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.


   
Fiscal Year 2010
 
   
High
   
Low
 
4th Quarter
  $ 0.64     $ 0.31  
3rd Quarter
  $ 0.73     $ 0.23  
2nd Quarter
  $ 0.65     $ 0.03  
1st Quarter
  $ 0.28     $ 0.05  
                 
                 
   
Fiscal Year 2009
 
   
High
   
Low
 
4th Quarter
  $ 0.65     $ 0.06  
3rd Quarter
  $ 0.25     $ 0.02  
2nd Quarter
  $ 0.72     $ 0.07  
1st Quarter
  $ 1.15     $ 0.51  

As of January 28, 2011, there were approximately 121 stockholders of record.  The last sale price as reported on the Over-the-Counter Bulletin Board on January 28, 2011, was $0.55.  We have never paid a cash dividend on our common stock and do not anticipate the payment of cash dividends in the foreseeable future.  In addition, our agreements with lenders prohibit the payment of cash dividends.
 
Securities Authorized for Issuance under Equity Compensation Plans as of the End of Fiscal 2010 Equity Compensation Plan Information
 
The table below sets forth certain information as of June 30, 2010 with respect to equity compensation plans under which our common stock is authorized for issuance:

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
 
Equity compensation plans
                   
approved by stockholders
    3,691,208  (1  )   $ 0.32       44,997  
Equity compensation plans not
                         
approved by stockholders
    -                 -  
      3,691,208                 44,997  

 
_______________
 
(1)
This total includes shares to be issued upon exercise of outstanding options under the equity compensation plans that have been approved by our stockholders (i.e., our 2000 Incentive and Non-Qualified Stock Option Plan and our 2004 Stock Option Plan).
 
 

 


 
 
 
-22-

 


 
 
Recent Sales of Unregistered Securities
 
During the three months ended June 30, 2010, DMRJ Group, LLC elected to convert $200,000 of the principal amount owed by us under a promissory note into 2,500,000 shares of our common stock, at an adjusted conversion price of $0.08 per share. The issuance of these securities to DMRJ is exempt from registration under the Securities Act of 1933, as amended, pursuant to an exemption provided by Section 3(a)(9) of the Securities Act.
 
In July 2010, Michael Turmelle, a member of our Board of Directors, elected to convert $100,000 of the principal amount owed by us under a promissory note into 1,250,000 shares of our common stock, at a conversion price of $0.08 per share. The issuance of these shares to Mr. Turmelle is exempt from registration under the Securities Act pursuant to an exemption provided by Section 3(a)(9) of the Securities Act.
 
Item 6.
Selected Financial Data
 
Not Applicable.
 
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements
 
This Annual Report on Form 10-K contains certain statements that are “forward-looking” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Litigation Reform Act”).  These forward looking statements and other information are based on our beliefs as well as assumptions made by us using information currently available.
 
The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “should” and similar expressions, as they relate to us, are intended to identify forward-looking statements.  Such statements reflect our current views with respect to future events, are subject to certain risks, uncertainties and assumptions, and are not guaranties of future performance.  Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected, intended or using other similar expressions.
 
In accordance with the provisions of the Litigation Reform Act, we are making investors aware that such forward-looking statements, because they relate to future events, are by their very nature subject to many important factors that could cause actual results to differ materially from those contemplated by the forward-looking statements contained in this Annual Report on Form 10-K.  Important factors that could cause actual results to differ from our predictions include those discussed under “Risk Factors,” this “Management’s Discussion and Analysis” and “Business.”  Although we have sought to identify the most significant risks to our business, we cannot predict whether, or to what extent, any of such risks may be realized, nor can there be any assurance that we have identified all possible issues which we might face.  In addition, assumptions relating to budgeting, marketing, product development 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 us to alter our marketing, capital expenditure or other budgets, which may in turn affect our financial position and results of operations.  For all of these reasons, the reader is cautioned not to place undue reliance on forward-looking statements contained herein, which speak only as of the date hereof.  We assume no responsibility to update any forward-looking statements as a result of new information, future events, or otherwise except as required by law.
 
Overview
 
Since our incorporation in August 1984, we have operated as a multi-faceted company engaging in the development of ion-based technologies and providing commercial services and products to the semiconductor, medical device and security industries.  Beginning in March 2007, we undertook steps to divest our semiconductor and medical business activities in order to focus on our security business.
 
Since May 1999, we have been performing research to improve explosives trace detection (“ETD”) technology, and developing ETD products which can be used for detection of trace amounts of explosives.  We now develop, manufacture and sell sophisticated sensors and systems for the Security, Safety and Defense (“SS&D”) industries.  We have developed handheld and benchtop ETD systems, which have been marketed and sold both domestically and internationally.  These systems are used by private companies and government agencies to screen baggage, cargo, vehicles, other objects and people, for the detection of trace amounts of explosives.
 


 
 
 
-23-

 


 
 
Critical Accounting Policies
 
Our significant accounting policies are described in Note 2 to the consolidated financial statements included in Item 8 of our Annual Report on Form 10-K for the fiscal year ended June 30, 2010.  Our discussion and analysis of our financial condition and results of operations are based upon these 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, derivative liabilities, conversion featires of our debt agreements, warranty obligations and impairment of goodwill.  We base our estimates on historical experience and on various other assumptions that we believe 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 have identified the following as critical accounting policies, based on the significant judgments and estimates used in determining the amounts reported in our financial statements:
 
·  
Revenue Recognition.  We recognize revenue when there is persuasive evidence of an arrangement with the customer that 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.  Our 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 we have received payment, but have not yet recognized the revenues, pending fulfilling our obligations under the sales agreement, are reflected on our balance sheet as deferred revenues.
 
·  
Accounts Receivable and Allowance for Doubtful Accounts.  We maintain allowances for estimated losses resulting from the inability of our 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 we are aware of a specific customer’s inability to meet its financial obligations to us (e.g., due to a bankruptcy filing), 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.
 
·  
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.
 


 
 
 
-24-

 


 
·  
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.
 
·  
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 $17,022,000 as of June 30, 2010, 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. Accounting Standards Codification (“ASC”) 350 “Intangibles – Goodwill and Other” requires that goodwill and intangible assets with indefinite lives no longer be amortized but instead is 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 June 30 as the date for performing our annual goodwill impairment test.  Future events could cause management to conclude that impairment indicators exist and that goodwill associated with our acquired businesses is impaired.  Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.  We determined that goodwill was impaired at June 30, 2010, resulting in a $3,136,000 charge recorded in our statement of operations for the year then ended.
 
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 that 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.  We continually evaluate 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 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.
 
·  
Equity Transactions.  We evaluate the proper classification of our equity 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. We record financing associated with our capital raising efforts in our 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 and allocate the proceeds amongst the securities based on relative fair values or based upon the residual method.  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.
 


 
 
 
-25-

 


 
·  
Warrant Derivative Liability.  Accounting Standards Codification (“ASC) 815-40-15 “Derivatives and Hedging”, requires freestanding contracts that are settled in our own stock, including common stock warrants to be designated as an equity instrument, asset or liability. Under the provisions of ASC 815, a contract designated as an asset or a liability must be carried at fair value until exercised or expired, with any changes in fair value recorded in the results of operations. In our December 10, 2008 financing transaction with DMRJ Group LLC, we issued a warrant to purchase 1,000,000 shares of our common stock. The warrant contains reset provisions, in the event that the company issues additional shares of common stock (or securities convertible into or exercisable for additional shares of common stock) at a price below the exercise price of the warrant will be automatically adjusted to equal the price per share at which such shares are issued or deemed to be issued. The warrant derivative liability should initially and subsequently be measured at fair value with changes in fair value recorded in earnings in each reporting period. For the year ended June 30, 2010, we recorded a non-cash charge of $217,000 in our statement of operations. Fair value is estimated using a binomial option pricing model, which includes variables such as the expected volatility of our share price, interest rates, and dividend yields. These variables are projected based on our historical data, experience, and other factors. Changes in any of these variables could result in material adjustments to the expense recognized for changes in the valuation of the warrant derivative liability.
 
·  
Fair Value of Note Conversion Feature. ASC 815-40-15 requires issuers to record, as liabilities, financial instruments that provide for reset provisions as an adjustment mechanism to the relevant exercise or conversion price, since they are not deemed to be indexed to our common stock. Under the provisions of ASC 815-40-15, a contract designated as an asset or a liability must be carried at fair value until exercised or expired, with any changes in fair value recorded in the results of operations. In our December 10, 2008 financing transaction with DMRJ Group LLC, we issued a senior secured promissory note in the principal amount of $5,600,000. The promissory note contains reset provisions, in the event that the company issues additional shares of common stock (or securities convertible into or exercisable for additional shares of common stock) at a price below the note conversion price will be automatically adjusted to equal the price per share at which such shares are issued or deemed to be issued. The conversion option liability should initially and subsequently be measured at fair value with changes in fair value recorded in earnings in each reporting period. For the year ended June 30, 2010, we recorded a non-cash charge of $9,503,000 in our statement of operations. Fair value is estimated using a binomial option pricing model, which includes variables such as the expected volatility of our share price, interest rates, and dividend yields. These variables are projected based on our historical data, experience, and other factors. Changes in any of these variables could result in material adjustments to the expense recognized for changes in the valuation of the note conversion liability.
 
·  
Cumulative Effect of Change in Accounting Principle. On July 1, 2009, we adopted the provisions of ASC 815-40-15.  In accordance with ASC 815-40-15, the cumulative effect of the change in accounting principle recorded by us in connection with a warrant to purchase shares of our common issued to DMRJ and the reset provision contained in the senior secured promissory note we issued to DMRJ, was recorded as an adjustment of the opening balance of retained earnings as summarized in the following table:
 
   
As reported on
   
As adjusted on
   
Cumulative Effect
 
   
June 30,
   
July 1,
   
of Change in
 
   
2009
   
2009
   
Accounting Principle
 
                   
Debt discount
  $ -     $ 352,000     $ 352,000  
Warrant derivative liability
    -       61,000       61,000  
Additional paid in capital
    61,290,000       61,130,000       (160,000 )
Senior secured convertible promissory note
    4,049,000       4,119,000       70,000  
Note conversion option liability
    -       1,183,000       1,183,000  
Accumulated deficit
    (72,678,000 )     (73,480,000 )     (802,000 )


 
 
 
-26-

 


 
·  
Stock-Based Compensation. Effective July 1, 2006, we adopted the fair value recognition provisions of the accounting standards which requires the expense recognition of the estimated fair value of all stock-based payments issued to employees.
 
The valuation of employee stock options is an inherently subjective process, since market values are generally not available for long-term, non-transferable employee stock options.  Accordingly, an option pricing model is utilized to derive an estimated fair value.  In calculating the estimated fair value of our stock options we use the Black-Scholes pricing model, which requires the consideration of the following six variables for purposes of estimating fair value:
 
·  
the stock option exercise price;
 
·  
the expected term of the option;
 
·  
the grant price of our common stock, which is issuable upon exercise of the option;
 
·  
the expected volatility of our common stock;
 
·  
the expected dividends on our common stock; and
 
·  
the risk-free interest rate for the expected option term.
 
Stock Option Exercise Price and Grant Date Price of our Common Stock.  Stock option exercise price is typically the closing market price of our common stock on the date of grant.
 
Expected Term.  The expected term of options granted is calculated using our historical option exercise transactions and reflects the period of time that options granted are expected to be outstanding.
 
Expected Volatility.  The expected volatility is a measure of the amount by which our stock price is expected to fluctuate during the expected term of options granted.  We determine the expected volatility solely based upon the historical volatility of our common stock over a period commensurate with the option’s expected term.  We do not believe that the future volatility of our common stock over an option’s expected term is likely to differ significantly from the past.
 
Expected Dividends.  We have never declared or paid any cash dividends on any of our capital stock and do not expect to do so in the foreseeable future.  Accordingly, we use an expected dividend yield of zero to calculate the grant-date fair value of a stock option.
 
Risk-Free Interest Rate.  The risk-free interest rate is the implied yield available on U.S. Treasury zero-coupon issues with a remaining term equal to the option’s expected term on the grant date.
 
Of the variables above, the selection of an expected term and expected stock price volatility are the most subjective.
 
Upon adoption of the fair value recognition provisions of the accounting standards, we were also required to estimate the level of award forfeitures expected to occur and record compensation expense only for those awards that are ultimately expected to vest.  This requirement applies to all awards that are not yet vested, including awards granted prior to July 1, 2006.  We have estimated a forfeiture rate of 10%, which estimate we will review periodically and as changes in the composition of our option pool dictate.
 
Changes in the inputs and assumptions, as described above, can materially affect the measure of estimated fair value of our share-based compensation.  We anticipate the amount of stock-based compensation to increase in the future as additional options are granted.  As of June 30, 2010, there was approximately $258,000 of unrecognized compensation cost related to stock option awards that is expected to be recognized as expense over a weighted average period of 2.7 years.
 


 
 
 
-27-

 


Results of Operations
 
Fiscal Year Ended June 30, 2010 vs. June 30, 2009
 
Revenues
 
Security revenues for the year ended June 30, 2010 were $3,474,000 as compared with $8,737,000 for the comparable prior fiscal year, a decrease of $5,263,000 or 60.2%.  Revenue from security products for the year ended June 30, 2010 was $3,043,000 as compared with $7,186,000 for the comparable prior year period, a decrease of $4,143,000 or 57.7%.  Revenue from government funded contracts and other services for the year ended June 30, 2010 was $431,000 as compared with $1,551,000 for the comparable prior year period, a decrease of $1,120,000 or 72.2%.  The decrease in security revenue is primarily a result of a decrease in the number of units of our explosives detection products sold in fiscal 2010 as compared to fiscal 2009, due primarily to significant shipments of our handheld explosives detection equipment to a customer in China aggregating approximately $4,169,000 in sales in the first quarter of fiscal 2009, which shipments coincided with security preparations for the Beijing Olympics. The decrease in government contract and other service revenue during fiscal 2010 as compared to the comparable prior year period was due the expiration of several contracts in fiscal 2010, which could result in reduced government contract revenues for fiscal 2011, unless we are successful in securing additional government contracts. We will continue to pursue these government grants and contracts to support our research and development efforts in the areas of trace explosives detection. 
 
Cost of Revenues
 
Cost of revenues for the year ended June 30, 2010 was $2,229,000 as compared with $4,656,000 for the comparable prior year, a decrease of $2,427,000 or 52.1%.   The decrease in cost of revenues is primarily a result of the decrease in unit sales of our security products.
 
Gross Margin
 
Gross margin for the year ended June 30, 2010 was $1,245,000 or 35.8% of security revenues as compared with $4,081,000 or 46.7% of security revenues for the comparable prior year.  The decrease in gross margin is the result  of competitive pricing pressures, increased per unit manufacturing overhead, as overhead costs were allocated to a reduced volume, an increase in quality assurance costs and minimum guaranteed royalties due on licensed technology.
 
Research and Development Expense
 
Research and development expense for the fiscal year ended June 30, 2010 was $2,399,000 as compared with $3,306,000 for the comparable prior year, a decrease of $907,000 or 27.4%.  The decrease in research and development expenses in fiscal 2010 is due primarily to decreased payroll and related fringe benefits costs resulting from a reduction in personnel, reduced material costs and reduced engineering consulting fees.
 
Selling, General and Administrative Expenses
 
Selling, general and administrative expenses for the year ended June 30, 2010 were $4,422,000 as compared with $7,554,000 for the comparable prior fiscal year, a decrease of $3,132,000, or 41.5%.   The decrease in selling, general and administrative expenses is due primarily to decreased legal fees, decreased payroll and related fringe benefits costs resulting from a reduction in personnel, decreased variable selling expenses due to the significant decrease in sales of our security products, decreased rent and related occupancy costs, decreased depreciation and amortization, partially offset by an increase in consulting fees.
 
Litigation Settlements
 
For year ended June 30, 2010, we recorded a lease termination benefit of $384,000 as compared with $0 for the comparable prior year period.  The lease termination benefit resulted from the dismissal of litigation related to Accurel’s lease obligations in California on October 28, 2009. Accurel has no further obligations or liabilities to the lessor under its lease.
 
For the year ended June 30, 2010, we recorded a $5,000,000 benefit resulting from the settlement of the litigation with Evans Analytical Group and John Traub.  On June 21, 2010, the parties resolved all claims arising from the Accurel sale, and Evans confirmed that 1,000,000 shares of Series E Convertible Preferred Stock granted to Evans in March 2009 had been cancelled.
 


 
 
 
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For year ended June 30, 2009, we recorded a $5,700,000 charge resulting from the settlement of the litigation with Evans.  In settling this litigation we released approximately $700,000 that had been held in escrow since the time of the closing of the Accurel sale and issued 1,000,000 shares of Series E Convertible Preferred Stock having an aggregate liquidation preference of $5,000,000.
 
Goodwill Impairment
 
For the year ended June 30, 2010 we recorded a $3,136,000 impairment charge to writedown the carrying value of goodwill, compared to $0 in the comparable prior period.
 
Other Income and Expense, Net
 
For the year ended June 30, 2010, we recorded other expense, net of $12,071,000 as compared with other expense, net of $1,080,000, for the comparable prior year period, an increase in other expense of $10,991,000.  The increase in other expense, net is primarily due to changes in fair value of the note conversion option liability, of $9,503,000 and warrant derivative liability of $217,000, both of which are related to our financing with DMRJ Group LLC, an increase in interest expense of $907,000 due to the amortization of debt discount and the initial warrant derivative and note conversion feature fair value related to our financing with DMRJ, increased borrowings under our credit facility with DMRJ and to higher interest rates on these borrowings. For the year ended June 30, 2009, interest expense included $568,000 assessed on the then-outstanding Series D Cumulative Convertible Preferred Stock owned by our former lender Laurus Master Fund Ltd., due to our failure to meet the amended redemption date, $90,000 of forbearance fees due to cure events of default under our former credit facility and $59,000 assessed by the State of California, resulting from a sales tax audit of Accurel that the Company is appealing.  Other factors attributing to the increase in other expense, net are:  the realized gain of $468,000 on the transfer of our investment in CorNova, Inc. common stock as part of the senior secured convertible promissory note issuance to DMRJ and $98,000 of realized loss on our share of CardioTech International stock owned by CorNova in the year ended June 30, 2009. Interest income increased $6,000 to $61,000, in the year ended June 30, 2010 from $55,000, for the comparable prior year period, due to interest income earned on restricted funds held in time deposits collateralizing letters of credit issued in conjunction with a large order from the India Ministry of Defence.
 
Loss from Continuing Operations
 
Loss from continuing operations for the year ended June 30, 2010 was $15,399,000 as compared with $13,559,000 for the comparable prior year, an increase of $1,840,000, or 13.6%.  The increase in loss from continuing operations is primarily the result the non-cash charges recorded due to changes in the fair value of the note conversion option liability of $9,503,000 and warrant derivative liability of $217,000, the $3,136,000 goodwill impairment charge, decreased gross margins due to lower revenues and higher per unit costs, increased interest expense and the $468,000 gain realized on the transfer of our CorNova common stock., offset partially by the $5,000,000 non-cash benefit  recorded due to  the settlement of the litigation with Evans and John Traub, a $5,700,000 non-cash charge recorded in comparable prior period due to the Evans litigation and settlement and a $4,040,000 reduction in operating expenses.
 
Preferred Distribution, Deemed Dividends and Accretion
 
Preferred distribution, deemed dividends and accretion on the Series F Preferred Stock for the year ended June 30, 2010 was $329,000 as compared with $207,000 on the Series D Preferred Stock for the comparable prior year, an increase of $122,000.  The Series F Preferred Stock, issued on July 1, 2009 and August 31, 2009, contained beneficial conversion features which amounted to $329,000 and is accounted for as a deemed dividend. The Series D Preferred Stock was extinguished on December 10, 2008.
 
Net Loss from Discontinued Operations
 
Net loss from discontinued operations for the year ended June 30, 2010 was $124,000 as compared with a net income of $808,000 for the comparable prior year, an increase of $932,000 or 115.3%.  The net loss from discontinued operations for fiscal 2010 is composed of operating loss of $124,000 from our medical reporting unit, which includes an impairment charge of $104,000 recorded on long-lived assets.  Net income from discontinued operations for the year ended June 30, 2009 includes: (i) operating income of $24,000 from our Core Systems subsidiary, which was sold during the second quarter of fiscal 2009, (ii) operating loss of $264,000 from our medical reporting unit, which includes an impairment charge of $143,000 recorded on long-lived assets (iii) gain on sale of Core Systems of $22,000 and (iv) gain on sale of assets of our medical reporting unit of approximately $1,026,000.
 


 
 
 
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Income Taxes
 
As of June 30, 2010, we had federal and state net operating loss carry forwards available to offset future taxable income of approximately $38,276,000 expiring between 2022 and 2031, and $34,962,000, expiring between 2011 and 2026, respectively.  As of June 30, 2010, we had federal and state investment, alternative minimum tax and research credit carry forwards available to offset future taxable income of approximately $729,000, expiring between 2022 and 2031, and $500,000, expiring between 2011 and 2026, respectively.
 
Liquidity and Capital Resources
 
As of June 30, 2010, we had a cash overdraft of approximately $11,000, an increase of $5,000 when compared with our cash overdraft of $6,000 as of June 30, 2009.
 
On March 31, 2011, we must repay in full our obligations to DMRJ under the amended and restated senior secured promissory note issued to DMRJ in March 2009, under a second secured promissory note issued in July 2009 and under a revolving credit facility established in September 2009. As of June 30, 2010, our obligations under the senior secured convertible promissory note, the senior secured promissory note and under the revolving credit facility were $3,920,000, $1,000,000 and $8,143,000, respectively. Each of these notes and the credit facility are described in more detail below.  As of December 31, 2010 our obligation to DMRJ under the senior secured convertible promissory note, the senior secured promissory note and under the revolving credit facility were $3,760,000, $1,000,000 and $10,994,000, respectively, reflecting increased borrowing under the revolving credit facility to fund working capital required to fulfill our order from the India Ministry of Defense.
 
On December 10, 2008, we used approximately $477,000 of the proceeds from the issuance of senior secured promissory note to DMRJ to repay all of the indebtedness outstanding to Bridge Bank, N.A., and the credit facility with the bank terminated. On December 10, 2008, we also used approximately $1,161,000 of the proceeds from the issuance of the note to redeem all of the Series D Preferred Stock held by Laurus Master Fund Ltd., excluding a portion of such stock which was redeemed effective on that date by the subsequent issuance of 929,535 shares of our common stock. As of June 30, 2009, the outstanding balance on the Series D Preferred Stock was $0.
 
During the year ended June 30, 2010 we had net cash outflows of $7,897,000 from operating activities of continuing operations as compared to net cash outflows of continuing operations of $3,985,000 for the comparable prior year period.  The approximately $3,912,000 decrease in net cash outflows used in operating activities of continuing operations during the year ended June 30, 2010, as compared to the comparable prior year period, was due to (i) a decrease in accounts payable of $1,364,000, compared to an increase in accounts payable of $1,860,000 in the prior period due to the payment of outstanding obligations; (ii) a decrease of $246,000 in deferred revenue, compared to a $362,000 increase in deferred revenue in the prior period due primarily to the timing of customer advance payments; (iii) a $428,000 increase in prepaid expenses, compared to a $79,000 increase in prepaid expenses in the prior period, due to vendor prepayment requirements on inventory procurement; (iv) a $414,000 increase in inventories, compared to a $164,000 decrease in inventories in the prior period, due to the acquisition of inventory in conjunction with an order from the India Ministry of Defence and (v) a $212,000 decrease in accounts receivable, compared to a $424,000 decrease in accounts receivable in the prior period. For the year ended June 30, 2010, we had net cash outflows of $47,000 from operating activities of discontinued operations, compared with net cash outflows of $33,000 from operating activities of discontinued operations for the comparable prior year period.
 
During the year ended June 30, 2010 we had net cash outflows of $1,187,000 from investing activities of continuing operations as compared to net cash inflows of $3,637,000 from investing activities of continuing operations for the comparable prior year period.  The approximately $4,824,000 decrease in net cash inflows used in investing activities of continuing operations during the year ended June 30, 2010, as compared to the comparable prior year period, was primarily a result of $1,377,000 decrease in payments received on the note issued as part of the consideration received from the sale of Core Systems,  net proceeds of $1,080,000 received from the sale of Core Systems $699,000 in net cash provided from the sale of assets of our medical business unit,  $1,362,000 increase in cash transferred to restricted funds to collateralize letters of credit issued in conjunction with an order from the India Ministry of Defence, compared to the receipt of $375,000 from restricted funds in the comparable prior period due mainly to the release of the Accurel sale escrow funds. For the year ended June 30, 2010, we had net cash outflows of $0 from investing activities of discontinued operations, compared to net cash outflows of $28,000 from investing activities of discontinued operations for the comparable prior year period, due primarily to a decrease in cash used to purchase property and equipment.
 


 
 
 
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During the year ended June 30, 2010 we had net cash inflows of $9,131,000 from financing activities of continuing operations as compared to net cash outflows of $2,000 from financing activities of continuing operations for the comparable prior year period.  The approximately $9,133,000 increase in net cash inflows used in financing activities of continuing operations during the year ended June 30, 2010, as compared to the comparable prior year period, was primarily due to $8,143,000 in cash borrowed under the credit facility provided by DMRJ in September 2009 and $1,000,000 in cash provided by the issuance of a senior secured note to DMRJ in July 2009. During the year ended June 30, 2009, we used $2,776,000 to pay dividends and redeem our Series D Preferred Stock, used $1,000,000 to repay our obligations under a senior secured convertible promissory note, used $764,000 to reduce our obligations to Bridge Bank under our term note and revolving credit facility, used $344,000 to repay other long-term debt and capital lease obligations and received $4,759,000 from our issuance of a senior secured convertible promissory note to DMRJ, received $100,000 of proceeds from the issuance of a note payable to a member of our Board of Directors and received $23,000 from the issuance of shares of our common stock under our employee stock purchase plan. For the year ended June 30, 2010, we had net cash outflows of $0 from financing activities of discontinued operations compared with net cash outflows of $1,000 from financing activities of discontinued operations for the comparable prior year period, due to decreased principal payments of capital lease obligations.  We expect that the absence of negative cash flows from our discontinued operations will have a favorable impact on our future liquidity and capital resources.
 
Credit Facilities from DMRJ Group LLC
 
On December 10, 2008, we entered into a note and warrant purchase agreement with DMRJ Group LLC, an accredited institutional investor, pursuant to which we issued a senior secured convertible promissory note in the principal amount of $5,600,000 and a warrant to purchase 1,000,000 shares of our common stock.  The note, which is collateralized by all of our assets, originally bore interest at 11.0% per annum.  The effective interest rate on the note, at the time of issuance, was approximately 23.4%.  We prepaid interest in the amount of $616,000 upon the issuance of the note.  In lieu of paying any commitment fees, closing fees or other fees in connection with the purchase agreement, we transferred our entire interest in 1,500,000 shares of the common stock of CorNova, Inc., a privately-held development stage medical device company, to DMRJ.  The note, which has been amended and restated, as described below, was originally convertible in whole or in part at the option of DMRJ into shares of our common stock at a conversion price of $0.26 per share.
 
In our December 10, 2008 financing transaction with DMRJ Group LLC, we issued a warrant to purchase 1,000,000 shares of our common stock. The warrant contains reset provisions, in the event that the company issues additional shares of common stock (or securities convertible into or exercisable for additional shares of common stock) at a price below the exercise price of the warrant will be automatically adjusted to equal the price per share at which such shares are issued or deemed to be issued. The warrant derivative liability should initially and subsequently be measured at fair value with changes in fair value recorded in earnings in each reporting period. The promissory note contains reset provisions, in the event that the we issue additional shares of common stock (or securities convertible into or exercisable for additional shares of common stock) at a price below the note conversion price, the conversion price will be automatically adjusted to equal the price per share at which such shares are issued or deemed to be issued. The conversion option liability should initially and subsequently be measured at fair value with changes in fair value recorded in earnings in each reporting period.
 
We valued the note upon issuance at its residual value of $4,341,000 based on the fair values of the financial instruments issued in connection with this convertible debt financing, including the warrant, the fair value of the note conversion option liability and the fair value of the CorNova common stock transferred to DMRJ.  The amounts recorded in the financial statements represents the amounts attributed to the senior secured convertible debt of $5,600,000, net of the fair value $153,000 allocated to the warrant, $638,000 allocated to the note conversion liability fair value $468,000 representing the estimated fair value of the CorNova common stock transferred to DMRJ in the financing transaction.  The note discount was calculated based upon the residual method.  The discount on the note is being amortized to interest expense over the term of the note.  The fair value of the warrant and note conversion liability were determined using a binomial option pricing model.  See Notes 15 and 16 for the assumptions used in calculating the fair values.
 


 
 
 
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For the years ended June 30, 2010 and 2009, we recorded $833,000 and $693,000 to interest expense in our statement of operations, respectively, to amortize the debt discount related to the $5,600,000 senior secured convertible promissory note. As required under the terms of the note, we made a principal payment of $1,000,000 on December 24, 2008.  The note required us to make a principal payment in an amount equal to any funds released from the escrow created in connection with the May 2007 sales of the assets of Accurel Systems International to Evans Analytical, upon the release of such funds.  DMRJ waived that requirement in connection with the settlement of the subsequent litigation with Evans.
 
Upon adoption of ASC 815-40-15 at July 1, 2009, we recorded a fair value note conversion option liability of $1,183,000 resulting in a $802,000 adjustment to the opening balance of accumulated deficit and reclassified the original fair value of the warrant from additional paid in capital to the warrant derivative liability as summarized in the following table:

   
As reported on
   
As adjusted on
   
Cumulative Effect
 
   
June 30,
   
July 1,
   
of Change in
 
   
2009
   
2009
   
Accounting Principle
 
                   
Debt discount
  $ -     $ 352,000     $ 352,000  
Warrant derivative liability
    -       61,000       61,000  
Additional paid in capital
    61,290,000       61,130,000       (160,000 )
Senior secured convertible promissory note
    4,049,000       4,119,000       70,000  
Note conversion option liability
    -       1,183,000       1,183,000  
Accumulated deficit
    (72,678,000 )     (73,480,000 )     (802,000 )
 
For the year ended June 30, 2010, we recorded a non-cash charge of $9,503,000 in our statement of operations to record the change in fair value of the note conversion option liability. Fair value is estimated using a binomial option pricing model, which includes variables such as the expected volatility of our share price, interest rates, and dividend yields. These variables are projected based on our historical data, experience, and other factors. Changes in any of these variables could result in material adjustments to the expense recognized for changes in the valuation of the warrant derivative liability and note conversion liability (see Note 15).
 
The note contains restrictions and financial covenants including:  (i) restrictions against declaring or paying dividends or making any distributions; against creating, assuming or incurring  any liens; against creating, assuming or incurring any indebtedness; against merging or consolidating with any other company, provided, however, that a merger or consolidation is permitted if we are the surviving entity; against the sale, assignment, transfer or lease of our assets, other than in the ordinary course of business and excluding inventory and certain asset sales expressly permitted by the note purchase agreement; against making investments in any company, extending credit or loans, or purchasing stock or other ownership interest of any company; and (ii) covenants that we have authorized or reserved for the purpose of issuance, 150% of the aggregate number of shares of our common stock issuable upon exercise of  the warrant; that we maintain a minimum cash balance of at least $500,000; that the aggregate dollar amount of all accounts payable be no more than 100 days past due; and that we maintain a current ratio, defined as current assets divided by current liabilities, of no less than 0.60 to 1.00.
 
On March 12, 2009, we entered into a letter agreement with DMRJ pursuant to which we were granted access to $250,000 of previously restricted cash out of funds held in a blocked account.  The effect of the letter agreement made $250,000 available to us until the close of business on April 14, 2009. In consideration of the letter agreement, on March 12, 2009, we issued an amended and restated senior secured convertible promissory note and amended and restated warrant to DMRJ to purchase shares of common stock, which replaced the note and warrant issued on December 10, 2008.  The terms of the amended and restated note and the amended and restated warrant are identical to the terms of the original note and warrant, except that the amended instruments reduced the initial conversion price of the original note from $0.26 to $0.18 and reduced the initial exercise price of the original warrant from $0.26 to $0.18.
 
On July 1, 2009, we entered into an amendment to the December 10, 2008 note and warrant purchase agreement with DMRJ, pursuant to which we issued a senior secured promissory note to DMRJ in the principal amount of $1,000,000.  We valued the note at its residual value of $726,000 based on the relative fair value of the Series F Convertible Preferred Stock issued in conjunction with the note (see Note 18).
 


 
 
 
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The senior secured promissory note, which has been amended, as described below, originally bore interest at the rate of 2.5% per month. The principal balance of the note, together with all outstanding interest and all other amounts owed under the note, was originally due and payable on the earlier of (i) December 10, 2009 and (ii) the receipt by us of net proceeds of at least $3,000,000 from the issuance of debt and/or equity securities in one or more transactions. In addition, DMRJ may require us to prepay such amounts upon (i) certain consolidations, mergers and business combinations involving us; (ii) the sale or transfer of more than 50% of our assets, other than inventory sold in the ordinary course of business, in one or more related or unrelated transactions; or (iii) the issuance by us, in one or more related or unrelated transactions, of any equity securities or securities convertible into equity securities (other than options granted to employees and consultants pursuant to employee benefit plans approved by our Board of Directors), which results in net cash proceeds to us of more than $500,000; provided, however, that DMRJ may not require us to prepay more than the net cash proceeds of any transaction described in the preceding clause (iii) of this sentence. We may prepay all or any portion of the principal amount of the note, without penalty or premium, after prior notice to DMRJ.
 
The amendment to the loan agreement provided that, in the event we had not obtained net proceeds from the issuance of debt or equity securities upon terms and conditions acceptable to DMRJ in its sole discretion of (i) $1,000,000 by July 24, 2009 and (ii) to the extent that we satisfied such requirements, an additional $2,000,000 by August 21, 2009, we would immediately engage in a sale process satisfactory to DMRJ in its sole discretion by implementing a contingency plan which may be established by DMRJ, including, without limitation, the engagement at our expense of a third party investment banker acceptable to DMRJ in its sole discretion.  We did not satisfy these requirements and, in August 2009, we engaged Pickwick Capital Partners to market our company for sale. As of June 30, 2010, we have not received any satisfactory proposals to acquire the company and are not actively marketing the company for sale.
 
In connection with the additional note issued on July 1, 2009, we also issued 871,763 shares of our Series F Convertible Preferred Stock to DMRJ, and agreed that, if we were unable to obtain net proceeds of at least $3,000,000 from the issuance of debt and/or equity securities by August 31, 2009, we would issue 774,900 additional shares of Series F Preferred Stock to DMRJ. DMRJ later extended this deadline until October 1, 2009. We did not satisfy this requirement and, on October 1, 2009, we issued the additional shares to DMRJ. The Series F Preferred Stock is convertible into that number of shares of common stock which equals the original issue price of the Series F Preferred Stock ($0.08 per share) divided by the “Series F Conversion Price.” All of the 1,646,663 shares of Series F Preferred Stock held by DMRJ were convertible into 16,466,630 shares of common stock, or 25% of our common stock, calculated on a fully diluted basis. In the event that we issue additional shares of common stock (or securities convertible into or exercisable for additional shares of common stock) at a price below the Series F Conversion Price then in effect, the Series F Conversion Price will be automatically adjusted to equal the price per share at which such shares are issued.  This reset provision completely protects an investor’s investment from subsequent price erosion until the occurrence of a liquidity event.  The reset provision will not apply, however, to issuances of stock and options to our employees, directors, consultants and advisors pursuant to any equity compensation plan approved by our stockholders.
 
In addition, for so long as the July 2009 note or the amended and restated senior secured convertible promissory note issued to DMRJ in March 2009 remain outstanding, we may not issue additional shares of common stock, or other securities convertible into or exercisable for common stock, if such securities would increase the number of shares of our common stock, calculated on a fully diluted basis, unless we simultaneously issue to DMRJ that number of additional shares of Series F Preferred Stock which is necessary to result in the number of shares of common stock into which all Series F Preferred Stock held by DMRJ may be converted representing the same percentage ownership of our common stock on a fully diluted basis after such issuance as immediately prior thereto.
 
After the repayment in full of the promissory notes, described above, the number of shares of common stock into which the Series F Preferred Stock is convertible will remain subject to reset provisions in the event that we issue additional shares of common stock (or securities convertible into or exercisable for additional shares of common stock) at a price below the Series F Conversion Price then in effect.
 
The Series F Preferred Stock is entitled to participate on an “as converted” basis in all dividends or distributions declared or paid on our common stock. In the event of any liquidation, dissolution or winding up of our company, the holders of the Series F Preferred Stock will be entitled to be paid an amount equal to $.08 per share of Series F Preferred Stock, plus any declared but unpaid dividends, prior to the payment of any amounts to the holders of our Series E Convertible Preferred Stock or common stock by reason of their ownership of such stock.
 


 
 
 
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The holders of the Series F Preferred Stock have no voting rights except as required by applicable law. However, without the consent of the holders of a majority of the Series F Preferred Stock, we may not (i) amend, alter or repeal any provision of our Restated Articles of Organization or By-laws in a manner that adversely affects the powers, preferences or rights of the Series F Preferred Stock; (ii) authorize or issue any equity securities (or any equity or debt securities convertible into equity securities) ranking prior and superior to the Series F Preferred Stock with respect to dividends, distributions, redemption rights or rights upon liquidation, dissolution or winding up; or (iii) consummate any capital reorganization or reclassification of any of our equity securities (or debt securities convertible into equity securities) into equity securities ranking prior and superior to the Series F Preferred Stock with respect to dividends, distributions, redemption rights or rights upon liquidation, dissolution or winding up.
 
The convertible promissory note conversion option and the warrant contains reset provisions, in the event that we issue additional shares of common stock (or securities convertible into or exercisable for additional shares of common stock) at a price below the amended conversion price then in effect, the note conversion price will be automatically adjusted to equal the price per share at which such shares are issued.  This reset provision completely protects an investor’s investment from subsequent price erosion until the occurrence of a liquidity event.  These reset provisions will not apply, however, to issuances of stock and options to our employees, directors, consultants and advisors pursuant to any equity compensation plan approved by our stockholders. Under ASC 815-40-15, the conversion option liability and the warrant should initially and subsequently be measured at fair value with changes in fair value recorded in earnings in each reporting period.
 
On August 5, 2009, we entered into a second amendment to the December 10, 2008 note and warrant purchase agreement with DMRJ, pursuant to which we issued DMRJ a bridge note in the principal amount of $700,000.  The note bore interest at the rate of 25% per annum. The outstanding principal balance and all interest due under this bridge note was paid on September 4, 2009.
 
On September 4, 2009, we entered into an additional credit agreement with DMRJ, pursuant to which DMRJ provided us with a revolving line of credit in the maximum principal amount of $3,000,000. In connection with the credit agreement, we issued a promissory note to DMRJ evidencing our obligations under the credit facility. Each of our subsidiaries guaranteed our obligations under the credit facility. Our obligations and our subsidiaries’ obligations are secured by grants of first priority security interests in all of our respective assets. In addition, we agreed to cause all of our receivables and collections to be deposited in a bank deposit account pledged to DMRJ pursuant to a blocked account agreement. All funds deposited in the blocked collections account are applied towards the repayment of our obligations to DMRJ under the note. Until the note and all of our obligations thereunder have been paid and satisfied in full, we will have no right to access or make withdrawals from the blocked account without DMRJ’s consent.
 
The revolving line of credit, which has been amended, as described below, originally bore interest at the rate of 25% per annum. Interest under the note is due on the first day of each calendar month. The principal balance of the note, together with all outstanding interest and all other amounts owed under the note, was originally due and payable on December 10, 2009. We may prepay all or any portion of the principal amount of the note, without penalty or premium, after prior notice to DMRJ. Subject to applicable cure periods, amounts due under the note are subject to acceleration upon certain events of default, including: (i) any failure to pay when due any amount owed under the note; (ii) any failure to observe or perform any other condition, covenant or agreement contained in the note or certain conditions, covenants or agreements contained in the credit agreement; (iii) certain suspensions of the listing or trading of our common stock; (iv) a determination that any misrepresentation made by us to DMRJ in the credit agreement or in any of the agreements delivered to DMRJ in connection with the credit agreement were false or incorrect in any material respect when made; (v) certain defaults under agreements related to any of our other indebtedness; (vi) the institution of certain bankruptcy and insolvency proceedings by or against us; (vii) the entry of certain monetary judgments against us that are not dismissed or discharged within a period of 20 days; (viii) certain cessations of our business in the ordinary course; (ix) the seizure of any material portion of our assets by any governmental authority; and (x) our indictment for any criminal activity.
 
In lieu of paying DMRJ any commitment fees, closing fees or other fees in connection with the credit agreement, we agreed to pay DMRJ an additional amount equal to 50% of or aggregate net profits, as defined, generated between the closing date through the termination of the credit facility. For the period September 4, 2009 through January 12, 2010, the date as of which this arrangement was cancelled, we experienced a net loss and no such payments were due or payable to DMRJ as of March 31, 2010.
 


 
 
 
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Upon the closing of the credit facility, we requested and were granted an initial advance of approximately $1,633,000, of which we used approximately $715,000 to repay all of our outstanding indebtedness to DMRJ pursuant to the bridge note issued to DMRJ on August 5, 2009, and approximately $548,000 to retire certain obligations owed to other parties. We used the balance of the initial advance for working capital and ordinary course general corporate purposes.
 
We failed to pay an aggregate of $7,505,678 in principal, together with approximately $149,292 of interest, due to DMRJ on December 10, 2009, the maturity of each of the promissory notes described above.  On December 20, 2009, we received written notice form DMRJ, stating that we were in default of our obligations under each of the notes.
 
As a result of these defaults, effective December 11, 2009, (i) the interest rate that we were obligated to pay to DMRJ under the promissory note issued in March 2009 automatically increased from 11% per annum to 2.5% per month (or the maximum applicable legal interest rate, if less); (ii) the interest rate that we were obligated to pay to DMRJ under the promissory note issued in July 2009 automatically increased from 2.5% per month to 3.0% per month (or the maximum applicable legal interest rate, if less); and (iii) the interest rate that we were obligated to pay to DMRJ under the promissory note issued in September 2009 increased from 25% per annum to 30% per annum (or the maximum applicable legal interest rate, if less). All such default interest is payable upon demand by DMRJ.
 
On December 31, 2009, we received further written notice from DMRJ, withdrawing its December 20, 2009 default notice. Also on December 31, 2009, DMRJ elected to convert $120,000 of the principal amount owed by us under the senior secured convertible promissory note into 1,500,000 shares of our common stock, at an adjusted conversion price of $.08 per share. DMRJ has subsequently converted additional portions of our indebtedness on similar terms. Under the promissory notes and related agreements, however, DMRJ may not convert any portion of the notes if the number of shares of common stock to be issued pursuant to such conversion, when aggregated with all other shares of common stock owned by DMRJ at such time, would result in DMRJ beneficially owning in excess of 4.99% of the then issued and outstanding shares of common stock. DMRJ may waive such limitation by providing us with 61 days’ prior written notice.
 
On January 12, 2010, we entered into an omnibus waiver and first amendment to credit agreement and third amendment to note and warrant purchase agreement with DMRJ pursuant to which: (i) our line of credit under the September 2009 credit agreement was increased from $3,000,000 to $5,000,000; (ii) the maturity of all of our indebtedness to DMRJ under each of the notes described above, was extended from December 10, 2009 to June 10, 2010; (iii) DMRJ waived all existing defaults under all of these promissory notes and all related credit agreements through the new maturity date of June 10, 2010; (iv) the interest rate payable on our obligations under each of the promissory notes was reduced to 15% per annum; (v) all arrangements pursuant to which we were to share with DMRJ any profits resulting from certain transactions were removed from the credit documents; (vi) we agreed to certain limitations on equity financings without DMRJ’s prior consent; and (vii) we agreed that we will not prepay more than $3,600,000 of the $5,600,000 of indebtedness owed to DMRJ under the March 2009 amended and restated promissory note without DMRJ’s prior consent.
 
On April 23, 2010 we entered into an omnibus second amendment to credit agreement and fourth amendment to note and warrant purchase agreement with DMRJ pursuant to which: (i) our line of credit under the September 2009 credit agreement was increased from $5,000,000 to $10,000,000; and (ii) the maturity of all of our indebtedness to DMRJ, including indebtedness under each of the promissory notes described in the preceding paragraphs was extended from June 10, 2010 to September 30, 2010.

On September 30, 2010, we entered into an omnibus third amendment to the credit agreement and fifth amendment to note and warrant purchase agreement  pursuant to which the maturity of all of the our indebtedness to DMRJ, including indebtedness in the preceding paragraphs, was extended from September 30, 2010 to March 31, 2011.
 


 
 
 
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Our ability to comply with our debt covenants in the future depends on our ability to generate sufficient sales and to control expenses, and will require us to seek additional capital through private financing sources.  There can be no assurances that we will achieve our forecasted financial results or that we will be able to raise additional capital to operate our business.  Any such failure would have a material adverse impact on our liquidity and financial condition and could force us to curtail or discontinue operations entirely and/or file for protection under bankruptcy laws.  Further, upon the occurrence of an event of default under certain provisions of our agreements with DMRJ, we could be required to pay default rate interest equal to the lesser of 3.0% per month and the maximum applicable legal rate per annum on the outstanding principal balance outstanding.
 
As of June 30, 2010, our obligations to DMRJ under the amended and restated senior secured convertible promissory note, the senior secured promissory note and under the credit facility approximated $3,920,000, $1,000,000 and $8,143,000, respectively.  Further, as of June 30, 2010, our obligation to DMRJ for accrued interest under the amended senior secured convertible promissory note, the senior secured promissory note and under the credit facility approximated $686,000.
 
As of December 31, 2010 our obligation to DMRJ under the senior secured convertible promissory note, as amended, the senior secured promissory note and under the credit facility approximated $3,760,000, $1,000,000 and $10,994,000, respectively. Further, as of December 31, 2010, our obligation to DMRJ for accrued interest under the amended senior secured convertible promissory note and the senior secured promissory note approximated $1,023,000.
 
The failure to refinance this indebtedness or otherwise negotiate extensions of our obligations to DMRJ would have a material adverse impact on our liquidity and financial condition and could force us to curtail or discontinue operations entirely and/or file for protection under bankruptcy laws.
 
There can be no assurance that we will be successful in refinancing or extending our obligations to DMRJ.  If we are successful, however, then, based on the current sales, expense and cash flow projections, and the proceeds from certain expected sales of assets, management believes it has plans in place to fund operations for the next 12 months.  Because there can be no assurances that sales will materialize as forecasted, and/or that management will be successful in executing these plans, management will continue to closely monitor and attempt to control our costs and will continue to actively seek the needed capital through government grants and awards, strategic alliances, private financing sources, and through its lending institutions.  Future expenditures for research and product development are discretionary and can be adjusted as can certain selling, general and administrative expenses, based on the availability of cash.  The financial statements do not include any adjustments relating to the recoverability and classification of asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.
 
Off-Balance Sheet Arrangements
 
As of June 30, 2010 we had four irrevocable standby letters of credit outstanding in the approximate amount of $1,906,000.
 
·  
A letter of credit in the amount of $418,000 provides performance security equal to 10% of the contract amount for product which shipped in the first quarter of fiscal 2009.  The letter of credit expired on July 31, 2010.
 
·  
Three letters of credit aggregating to $1,488,000 (1) provides performance security equal to 5% of the contract amount; (2) provides warranty performance security equal to 5% of the contract amount; and, (3) provides security equal to 15% of the contract amount against an advance deposit under the terms of an order from the India Ministry of Defence.  The letters of credit expire between December 21, 2010 – October 5, 2012.
 
As of June 30, 2010, we did not have any other off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.
 


 
 
 
-36-

 


Recent Accounting Pronouncements
 
In June 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Accounting Standards Codification (“ASC”) 105, “Generally Accepted Accounting Principles,” which establishes the FASB Accounting Standards Codification as the sole source of authoritative generally accepted accounting principles. Pursuant to the provisions of ASC 105, we have updated references to generally accepted accounting principles (“GAAP”) in our financial statements issued for the year ended June 30, 2010. The adoption of ASC 105 did not impact our consolidated financial position or results of operations.
 
In October 2009, the FASB issued Accounting Standards Update No. 2009-13, “Revenue Recognition (Topic 605) Multiple-Deliverable Revenue Arrangements (A Consensus of the FASB Emerging Issues Task Force)” (ASU 2009-13), which amends existing accounting standards for revenue recognition for multiple-element arrangements. This update removes the objective-and-reliable-evidence-of-fair-value criterion from the separation criteria used to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting, replaces references to “fair value” with “selling price” to distinguish from the fair value measurements required under the “Fair Value Measurements and Disclosures” guidance, provides a hierarchy that entities must use to estimate the selling price, eliminates the use of the residual method for allocation, and expands the ongoing disclosure requirements. This update is effective for fiscal years beginning on or after June 15, 2010, and can be applied prospectively or retrospectively. We do not currently believe that the adoption of this update will have any effect on our consolidated financial position and results of operations.
 
In February 2008, the FASB issued ASC 820-10-65-1, “Fair Value Measurements and Disclosures”.  ASC 820-10-65-1 delayed the effective date of ASC 820-10 for nonfinancial assets and nonfinancial liabilities, except for certain items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) until fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. We adopted the provisions of ASC 820-10 for nonfinancial assets and nonfinancial liabilities effective July 1, 2009.  The adoption of these provisions did not have a material impact on our Consolidated Financial Statements.

In June 2008, the FASB issued ASC 260-10-55-76C, “Earnings per Share — Implementation Guidance,” effective for fiscal years beginning after December 15, 2008.  ASC 260-10-55-55-76C clarifies that unvested share-based awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and must be included in the computation of EPS pursuant to the two-class method. We adopted the provisions of ASC 260-10-55-55-76C effective July 1, 2009.The adoption of ASC 260-10-55-55-76C did not have a material impact on reported earnings per share.

In June 2008, the FASB issued ASC 815-40-15, “Derivatives and Hedging.” FASB ASC 815-40-15 addresses the determination of whether provisions that introduce adjustment features (including contingent adjustment features) would prevent treating a derivative contract or an embedded derivative on a company’s own stock as indexed solely to the company’s stock. ASC 815-40-15 is effective for fiscal years beginning after December 15, 2008. We adopted the provisions of ASC 815-40-15 effective July 1, 2009.  The adoption of these provisions did have a material impact on our consolidated financial position and results of operations.

 
 
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
 
 
Not Applicable.
 

 

 


 
 
 
-37-

 


Item 8.
Financial Statements and Supplementary Data
 
The following documents are filed as part of this report on Form 10-K
 
   
Page
 
Report of Marcum LLP, Independent Registered Public Accounting Firm
 
F-1
 
Report of UHY LLP, Independent Registered Public Accounting Firm
 
F-2
 
Consolidated Balance Sheets at June 30, 2010 and 2009
 
F-3
 
Consolidated Statements of Operations for the years ended June 30, 2010 and 2009
 
F-4
 
Consolidated Statements of Stockholders’ Deficit for the years ended June 30, 2010 and 2009
 
F-5
 
Consolidated Statements of Cash Flows for the years ended June 30, 2010 and 2009
 
F-6 to F-7
 
Notes to Consolidated Financial Statements
 
F-8
 
 
Item 9.
Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
 
None.
 
Item 9A.
Controls and Procedures
 
The certifications of our Chief Executive Officer and Chief Financial Officer attached as Exhibits 31.1 and 31.2 to this Annual Report on Form 10-K include, in paragraph 4 of such certifications, information concerning our disclosure controls and procedures, and internal control over financial reporting.  Such certifications should be read in conjunction with the information contained in this Item 9A for a more complete understanding of the matters covered by such certifications.
 
 
Disclosure Controls and Procedures.
 
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2010.  The term “disclosure controls and procedures”, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions to be made regarding required disclosure.  It should be noted that any system of controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met and that management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Our management identified a material weakness in respect of our internal controls over financial reporting, specifically in our controls over the adoption of Accounting Standards Codification (“ASC”) 815-40-15 - Derivatives and Hedging.” related to the non-cash accounting treatment of financial instruments which are not deemed to be indexed to the company’s common stock. Further, we are restating the aforementioned quarters to record, as of July 1, 2009 and August 31, 2009, the commitment dates of our Series F Convertible Preferred Stock, to record the deemed dividend resulting from the beneficial conversion feature contained in the Series F Convertible Preferred Stock, as required under Accounting Standards Codification (“ASC”) 470-20 “Debt.” We will restate the condensed consolidated financial statements included in its Quarterly Reports on Form 10-Q for the fiscal quarters ended September 30, 2009, December 31, 2009 and March 31, 2010. As a result of this material weakness, our Chief Executive Officer and Chief Financial Officer, concluded that, we did not maintain effective internal control over financial reporting as of June 30, 2010 and further concluded that, as of such date, our disclosure controls and procedures were not effective at the reasonable assurance level.
 


 
 
 
-38-

 


Management’s Annual Report on Internal Control Over Financial Reporting
 
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act).  A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.  Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the interim or annual consolidated financial statements.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2010 based on the framework in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on this assessment, our management concluded that, as of June 30, 2010, our internal control over financial reporting was not effective based on those criteria.
 
This Annual Report on Form 10-K does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting.  Management's report was not subject to attestation by our  registered public accounting firm pursuant to provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that permit us to provide only management's report in this Annual Report.
 
Remediation
 
We are committed to remediating the material weakness identified in our implementation of new accounting pronouncements. To remediate our material weakness we have recruited a senior accounting professional which will enhance the overall technical abilities of our accounting department.  This individual will assist with the preparation of our financial statements and with the documentation of our review of financial statements and schedules.  Further, we will evaluate additional training for existing personnel in the areas of GAAP and will take the necessary steps to improve our internal process of identifying, researching and evaluating the impact of new accounting pronouncements. This additional resource will enhance our GAAP capabilities related to review procedures, strengthen our segregation of duties as well as enhance our ability to account and report on complex material and/or non-routine transactions.
 
Changes in Internal Control Over Financial Reporting
 
Except as described above, there were no changes to our internal control over financial reporting during the fourth quarter ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
Item 9B.
Other Information
 
None.
 


 
 
 
-39-

 

PART III

Item 10.
Directors, Executive Officers and Corporate Governance
 
In May 2009, our Board of Directors increased the size of the board from five directors to seven directors.  Our Board of Directors is currently comprised of six directors.  The directors and named executive officers, their ages and positions, as well as certain biographical information of these individuals, are set forth below.  The ages of the individuals are provided as of September 30, 2010.
 
There are no family relationships between any director, named executive officer, or person nominated or chosen to become a director or executive officer.

Name
 
Age
 
Position
Glenn D. Bolduc
 
58
 
Chairman of the Board, President and Chief Executive Officer
Brenda L. Baron
 
48
 
Vice President, Manufacturing and Technical Services
Bruce R. Bower
 
65
 
Senior Vice President
Roger P. Deschenes
 
52
 
Vice President, Finance and Chief Financial Officer
Todd A. Silvestri
 
44
 
Vice President, Advanced Technology and Product Development
John A. Keating
 
57
 
Director
Joseph E. Levangie
 
65
 
Director
Robert P. Liscouski
 
56
 
Director
Howard Safir
 
69
 
Director
Michael C. Turmelle
 
51
 
Director
 
Glenn D. Bolduc has served as Chairman of the Board since May 2009 and as President and Chief Executive Officer since January 2009, having joined us as Chief Financial Officer in July 2008. Prior to joining the Company, Mr. Bolduc served as acting CEO and CFO of Horizon’s Edge Casino Cruises, LLC.  From January 2001 through January 2006 Mr. Bolduc was the principal of Radius Ventures LLC, a strategic advisory firm.  Prior to Radius Ventures, Mr. Bolduc has held executive management and financial positions, including CEO and CFO, with several venture-backed and publicly-held companies in various technology industries.  From 1996 to 1999, Mr. Bolduc served as President and Chief Executive Officer of Vialog Corporation. Mr. Bolduc received his undergraduate degree in accounting from Fairleigh Dickinson University and began his accounting career with PriceWaterhouseCoopers.
 
Our Board of Directors has concluded that Mr. Bolduc is uniquely qualified to serve as a director and Chairman of our Board based on his past and current leadership and executive roles, financial skills and business judgment.
 
Brenda L. Baron has served as our Vice President, Manufacturing and Technical Services since February, 2009, having joined the company in April 2004.  Ms. Baron developed the Security Division's manufacturing operations, as well as manufacturing, test, and documentation control. Prior to joining the Company, Ms. Baron served as Documentation Engineer with the instrumentation division of Milipore Corporation, from 2002 to 2004, and was employed at Ion Track Instruments, an explosives trace detector manufacturer as  Configuration Manager, from 1998 to 2001, where she played a key role in bringing handheld, bench top, and portal trace detectors into production.
 
Bruce R. Bower joined us in August 2001 as Senior Vice President. From February 2009 through November 2009 and from February 2010 through the date of his appointment as Senior Vice President, Mr. Bower served as strategic advisor to our Chief Executive Officer.  From November 2009 through January 2010, Mr. Bower was employed by us as a special assistant to the Chief Executive Officer. Mr. Bower has more than 25 years of sales, sales management, marketing and general management experience with technology companies selling hardware and software solutions to enterprise and government customers worldwide. Prior to joining the Company he served as Vice President Sales and Marketing and President, CEO for both Teloquent Communications and MultiLink and held Sales, Product Management, and General Management roles with ROLM and IBM. Mr. Bower holds a M.B.A. from Boston University.
 


 
 
 
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Roger P. Deschenes joined us in June 2008 as Controller, was promoted to Vice President, Finance in January 2009 and to Chief Financial Officer in July 2010. Mr. Deschenes has more than 25 years of accounting and financial leadership experience with publicly traded and private companies. Prior to joining Implant Sciences, Mr. Deschenes served as Vice President, Finance with Beacon Roofing Supply, Inc. from 2006 to 2007. From 1990 to 2006, Mr. Deschenes served in several senior accounting and financial capacities at Saucony, Inc. including: Vice President, Controller, Chief Accounting Officer and Assistant Treasurer.  Mr. Deschenes received a B.S. in Business Administration from Salem State University and is a Certified Management Accountant.
 
Todd A. Silvestri joined us in September 2008 and is directly responsible for the design and commercialization of the Company’s advanced explosive trace detection solutions. Previously, Mr. Silvestri was Senior Vice President of Century Capital Partners, assisting his clients in defining optimal exiting strategies, securing capital, and expanding into foreign markets. Prior to that, he led New Product Development for Environmental Systems Products (ESP), where he was responsible for expanding the Company’s traditional business-to-government services into new frontiers by commercializing products and services for private business clients and consumers. In 2003, Mr. Silvestri founded APAC Global LLC providing consulting in the areas of company establishment, localization/relocation of operations, supply chain management, and organizational design primarily focused with small to medium sized companies expanding to, or within, the Asia Pacific Region. Mr. Silvestri holds a Masters Degree in Business from the Kellogg School of Management at Northwestern University, as well as a B.S. in Chemical Engineering from Clarkson University.
 
John A. Keating has served our board of directors since May 2009.  Mr. Keating has served the as the Vice President of Global Customer Fulfillment at Timberland Company, a premium global footwear brand with sales in excess of $1.2 billion in 2008, since 1992. Mr. Keating is responsible for all transportation, distribution, customs, and order management. In addition, Mr. Keating oversees North American customer service and apparel sourcing operations.  Mr. Keating holds a B.A. degree from Bridgewater State University and a M.B.A. from Suffolk University.
 
Our Board of Directors has concluded that Mr. Keating is uniquely qualified to serve as a director based on his experience and leadership rolls as an executive of a public company and his knowledge of transportation and distribution operations.
 
Joseph E. Levangie has served on our board of directors since December 2007.  Mr. Levangie has served as Chief Executive Officer of JEL & Associates, a business advisory firm, since 1981.  Mr. Levangie has held many executive positions including Chief Financial Officer of Greenman Technologies, Inc., Chief Operating & Financial Officer of Colorgen, Inc., Vice President, Corporate Development and Chief Financial Officer of Spire Corporation and Executive Vice President of The Solar Energy & Energy Conservation Bank. Mr. Levangie holds a S.B. in Chemical Engineering from the Massachusetts Institute of Technology and a M.B.A from the Harvard Graduate School of Business Administration.  Mr. Levangie served as a director of SatCon Technology Corporation from December 2004 to December 2007.
 
Our Board of Directors has concluded that Mr. Levangie is uniquely qualified to serve as a director based on his leadership role and experience as an executive at several public companies and his professional credentials.
 
Robert P. Liscouski has served on our board of directors since May 2009.  Since July 2009, Mr. Liscouski has served as lead of strategic and business development programs at Secure Strategy Group, a homeland security-focused banking and strategic advisory firm. Mr. Liscouski was the first Assistant Secretary for Infrastructure Protection for the Department of Homeland Security, serving from March 2003 to February 2005 and reporting directly to then Secretary Tom Ridge.  Mr. Liscouski’s private sector experience includes serving as the CEO of Content Analyst, a software company that automates the analysis and categorization of large volumes unstructured text and data, as Director of Information Assurance for The Coca-Cola Company and Vice President, Law Enforcement Division, for IRION Scientific Systems.  Mr. Liscouski’s government experience includes several years with the Diplomatic Security Service of the U.S. Department of State.  Mr. Liscouski is a Senior Fellow at the Center of Strategic and International Studies in Washington, D.C. and serves as an advisor to the U.S. government on technology matters.  Mr. Liscouski holds a B.S. degree in Criminal Justice from John Jay College of Criminal Justice and a Masters of Public Administration from the Kennedy School of Government, Harvard University.
 
Our Board of Directors has concluded that Mr. Liscouski is uniquely qualified to serve as a director based on his experience and leadership roles in public safety and security as a senior official with the Department of Homeland Security and based on his experience and leadership roles in the private sector.
 


 
 
 
-41-

 


Howard Safir has served on our board of directors since May 2009.  Mr. Safir has served as Chief Executive Officer of the security consulting and investigations unit of GlobalOptions Group, Inc., since May 2006 and as Chairman, Chief Executive Officer and Principal of the November Group a company that provides strategic advisory and customer acquisition services to companies in the security, law enforcement, intelligence and defense industries. Mr. Safir was the founder, Chairman and Chief Executive Officer of Safir Rosetti, LLC, a premier security consulting company, from December 2001 until its acquisition in May 2006 by GlobalOptions Group, Inc. Prior to that time, Mr. Safir was Vice Chairman of IPSA International, a provider of investigative and security consulting services. In 1996, Mr. Safir was appointed the 39th Police Commissioner of the City of New York by Mayor Rudolph W. Giuliani, after serving as New York City’s 29th Fire Commissioner for the prior two years, making him the only individual in the history of New York City to serve as both police and fire commissioner. Previously, he was the Assistant Director of the Drug Enforcement Agency and also served as Chief of the Witness Security Division, U.S. Marshals Service. Mr. Safir currently serves as a director of Verint Systems, Inc. and LexisNexis Special Services, Inc., a private company.  From February 2004 to October 2006, Mr. Safir served as Chairman of the Board of Directors of GVI Security Solutions, Inc., a provider of video surveillance and security solutions products and from June 2005 to July 2006 served as a director of Blastgard International, Inc., a developer and designer of proprietary blast mitigation materials, both of which are public companies.  Mr. Safir also served as a Chairman of the Board of Directors of National Security Solutions Inc., from March 2008 to April 2010, a private company organized for the purpose of effecting a business combination, including with entities involved in the security and homeland defense industries. Mr. Safir received his B.A. in History and Political Science from Hofstra University in 1963. He attended Harvard University's John F. Kennedy School of Government, receiving certificates in the programs for Senior Managers in Government in 1988 and for National and International Security in 1989.  Mr. Safir is a member of the Board of Trustees of Hofstra University and a director of the foundation of the International Association of Chiefs of Police.
 
Our Board of Directors has concluded that Mr. Safir is uniquely qualified to serve as a director based on his experience and leadership roles in public safety and security and his extensive service as a director and board chairman of public companies involved in the security and homeland defense industries.
 
Michael C. Turmelle has served on our board of directors since December 2005.  Since June 2010, Mr. Turmelle has served as the Chief Financial Officer of American EcoThermal, Inc., a company that provides geothermal renewal energy systems for use in homes and businesses.  From 2006 to 2010 Mr. Turmelle served as the Chief Financial Officer for 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 joining SatCon, Mr. Turmelle worked for HADCO Corporation.  Mr. Turmelle holds a B.A. degree in Economics from Amherst College.
 
Our Board of Directors has concluded that Mr. Turmelle is uniquely qualified to serve as a director based on his past and current leadership and executive roles, financial and operational skills, business judgment and knowledge of corporate governance matters.
 
Section 16(a) Beneficial Ownership Reporting Compliance
 
Section 16(a) of the Securities Exchange Act of 1934 requires our executive officers, directors and persons who beneficially own more than 10% of a registered class of our securities to file reports of ownership and changes in ownership with the SEC.  Based solely on a review of copies of such forms submitted to the company, we believe that all persons subject to the requirements of Section 16(a) filed such reports on a timely basis in fiscal 2010, with the exception of Mr. Michael C. Turmelle who failed to timely file one such report.
 
Code of Conduct and Ethics
 
We have adopted a code of ethics that applies to our chief executive officer and chief financial officer.  The code of ethics is posted on our website at www.implantsciences.com.  We intend to include on our website any amendments to, or waivers from, a provision of our code of ethics that applies to our chief executive officer and chief financial officer that relates to any element of the code of ethics definition enumerated in Item 406 of Regulation S-K.
 


 
 
 
-42-

 


Stockholder Communications with the Board of Directors
 
Pursuant to procedures set forth in our bylaws, our Nominating/Corporate Governance Committee will consider stockholder nominations for directors if we receive timely written notice, in proper form, of the intent to make a nomination at a meeting of stockholders.  To be timely, the notice must be received within the time frame identified in our bylaws, discussed below.  To be in proper form, the notice must, among other matters, include each nominee’s written consent to serve as a director if elected, a description of all arrangements or understandings between the nominating stockholder and each nominee and information about the nominating stockholder and each nominee.  These requirements are detailed in our amended and restated bylaws, which were attached as an exhibit to our Report on Form 8-K filed on December 18, 2007.  A copy of our bylaws will be provided upon written request.
 
Stockholder proposals submitted pursuant to Rule 14a-8 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) for inclusion in our proxy materials for our 2011 Annual Meeting of Stockholders must be received by the Clerk of the Company at the principal offices of the Company no later than September 1, 2011.
 
Our bylaws require advance notice of any proposal by a stockholder intended to be presented at an annual meeting that is not included in our notice of annual meeting and proxy statement because it was not timely submitted under the preceding paragraph, or made by or at the direction of any member of the board of directors, including any proposal for the nomination for election as a director.
 
The Board will give appropriate attention to written communications that are submitted by stockholders, and will respond if and as appropriate.  Stockholders who wish to send communications on any topic to the Board should address such communications to Board of Directors c/o Chief Executive Officer, Implant Sciences Corporation, 600 Research Drive, Wilmington, MA 01887.
 
Board Attendance
 
The Board of Directors met three (3) times and held twelve (12) meetings by telephone conference call during the year ended June 30, 2010.  Each director attended in excess of 75% of the total number of meetings of the Board of Directors and of the committees on which he served during fiscal 2010.
 
The Board of Directors has three standing committees; Audit Committee, Compensation Committee and Nominating/Corporate Governance Committee.  The membership of each, as of September 30, 2010, is indicated in the table below.

           
Nominating /
           
Corporate
Director
 
Audit
 
Compensation
 
Governance
John A. Keating
           
Joseph E. Levangie
 
Chairman
 
X
 
X
Robert R. Liscouski
         
X
Howard Safir
     
X
   
Michael C. Turmelle
 
X
 
Chairman
 
Chairman
 
Nominating/Corporate Governance Committee
 
The Nominating/Corporate Governance Committee consists of Messrs. Joseph Levangie, Robert Liscouski and Michael Turmelle, each of whom is an “independent” director, and Michael C. Turmelle serves as chairman of the Nominating/Corporate Governance Committee.  The Nominating/Corporate Governance Committee leads the Board’s effort at ensuring we have qualified directors by: (i) identifying individuals qualified to become Board members consistent with criteria approved by the Board and recommending to the Board a group of director nominees for each annual meeting of stockholders; (ii) recommending nominees to fill any vacancies which may occur during the year; (iii) considering candidates for nominees as directors of the Company who are recommended by stockholders entitled to do so under our Bylaws; and (iv) ensuring that the Audit, Compensation and Nominating/Corporate Governance Committees of the Board have qualified and experienced “independent” directors.  The Board has adopted a written charter for the Nominating/Corporate Governance Committee which is posted on our website at www.implantsciences.com.
 


 
 
 
-43-

 


 
In the event that the Nominating/Corporate Governance Committee or the Board identifies the need to fill a vacancy or to add a new member to fill a newly created position on the Board with specific criteria, the Nominating/Corporate Governance Committee initiates a search process and keeps the Board apprised of its progress. The Nominating/Corporate Governance Committee may seek input from members of the Board, the Chief Executive Officer and other management and, if necessary, hire a search firm. In addition, as a matter of policy, the Nominating/Corporate Governance Committee will consider candidates for Board membership properly recommended by stockholders. The initial candidate or candidates, including anyone recommended by a stockholder, who satisfy the specific criteria for Board membership and otherwise qualify for membership on the Board are reviewed and evaluated by the Nominating/Corporate Governance Committee. The evaluation process for candidates recommended by stockholders is the same as the process used to evaluate candidates recommended by any other source.  During the fiscal year ended June 30, 2010, the Nominating/Corporate Governance Committee did not meet.
 
Audit Committee
 
The Audit Committee was established in accordance with Section 3(a)(58)(A) of the Exchange Act.  The Board has designated from among its members Mr. Joseph E. Levangie and Mr. Michael C. Turmelle as the members of the Audit Committee.  The primary functions of the Audit Committee are to represent and assist the Board of Directors with the oversight of:
 
·  
appointing, approving the compensation of, and assessing the independence of our independent auditors;
 
·  
overseeing the work of our independent auditors, including through the receipt and consideration of certain reports from the independent auditors;
 
·  
reviewing and discussing with management and the independent auditors our annual and quarterly financial statements and related disclosures;
 
·  
coordinating the Board of Director’s oversight of our internal control over financial reporting, disclosure controls and procedures and code of conduct and ethics;
 
·  
establishing procedures for the receipt and retention of accounting related complaints and concerns;
 
·  
meeting independently with our independent auditors and management; and
 
·  
preparing the audit committee report required by SEC rules.
 
The Board of Directors has determined that Mr. Levangie, who serves as the Chairman of the Audit Committee, is an “audit committee financial expert” as defined in Item 407(d)(5)(ii) of Regulation S-K.
 
During the fiscal year ended June 30, 2010, the Audit Committee met six (6) times.  The responsibilities of the Audit Committee are set forth in its written charter, which is posted on our website at www.implantsciences.com under the “Investor Relations – Corporate Governance” section.
 
Compensation Committee
 
The Compensation Committee consists of Messrs. Michael C. Turmelle, Howard Safir and Joseph E. Levangie.  Mr. Turmelle serves as chairman of the Compensation Committee.  The Compensation Committee is responsible for implementing our compensation philosophies and objectives, establishing remuneration levels for our executive officers and implementing our incentive programs, including our equity compensation plans.  The Board of Directors has determined that each of the members of the Compensation Committee is an “independent” director within the meaning of the NYSE Amex (formerly, American Stock Exchange) listing standards and meets the independence requirements of Section 162(m) of the Internal Revenue Code, as amended.  During the fiscal year ended June 30, 2010, the Compensation Committee met four (4) times.  The responsibilities of the Compensation Committee are set forth in its written charter, which is posted on our website at www.implantsciences.com.
 


 
 
 
-44-

 


Compensation is paid to our executive officers in both fixed and discretionary amounts which are established by the Board of Directors based on existing contractual agreements and the determinations of the Compensation Committee.  Pursuant to its charter, the responsibilities of the Compensation Committee are (i) to assist the Board of Directors in discharging its responsibilities in respect of compensation of our senior executive officers; (ii) review and analyze the appropriateness and adequacy of our annual, periodic or long-term incentive compensation programs and other benefit plans and administer those compensation programs and benefit plans; and (iii) review and recommend compensation for directors, consultants and advisors.  Except for the delegation of authority to the Chief Executive Officer to grant certain de minimus equity compensation awards to our non-executive employees, the Compensation Committee has not delegated any of its responsibilities to any other person.
 
Risk Oversight
 
The Board of Directors is responsible for oversight of our risk management process. Our senior management is responsible for risk management on a day-to-day basis, including identifying risks, managing risks, and reporting and communicating risks back to the Board of Directors. The Board of Directors, including Board Committees comprised solely of independent directors, reviews various areas of significant risk to the Company, and advises management on policies, strategic initiatives, annual report on internal controls and other actions. Specific examples of risks primarily overseen by the full Board of Directors include competition risks, industry risks, economic risks, business operations and employee compensation risks and risks related to acquisitions and dispositions.
 
The Committees are primarily responsible for considering and overseeing risks within their particular area of concern. For example, as provided in its charter, the Audit Committee meets regularly with management, our independent registered public accountants and our internal auditors, to discuss the integrity of our financial reporting processes and internal controls as well as the steps that have been taken to monitor and control risks related to such matters. The Nominating and Corporate Governance Committee monitors compliance with the Code of Business Conduct and Ethics and reviews compliance with applicable laws and regulations related to corporate governance. The Compensation Committee reviews and evaluates risks related to the design and implementation of all general compensation programs applicable to our employees, including an annual review of both the design and the application of compensation and benefits programs.



 
 
 
-45-

 


Item 11.
Executive Compensation
 
Summary Compensation Table
 
The following table provides information concerning compensation earned in the last two fiscal years ended June, 2010 and 2009 by our Chief Executive Officer, Chief Financial Officer, and other most highly compensated executive officers whose total compensation exceeded $100,000 for the fiscal years ended June 30, 2010 and 2009:

Name and Principal Position
Fiscal Year
 
Salary
($)
   
Bonus
($)
   
Option Awards
($) (1)
   
All Other Compensation
($) (2)
   
Total
($)
 
Named Executive Officers
                               
Glenn D. Bolduc (3)
Chairman, President and
Chief Executive Officer
2010
  $ 323,654     $ -     $ 56,780     $ 12,408     $ 392,842  
 
2009
  $ 219,231     $ 136,250     $ 42,210     $ 9,792     $ 407,483  
                                           
Bruce R. Bower (4)
Senior Vice President
2010
  $ 24,400     $ -     $ 3,403     $ 169,800     $ 197,603  
 
2009
  $ -     $ -     $ 579     $ 55,200     $ 55,779  
                                           
Todd A. Silvestri (5)
Vice President, Advanced
Technology and Product Development
2010
  $ 169,192     $ -     $ 9,764     $ 6,225     $ 185,181  
 
2009
  $ 110,893     $ 62,000     $ 6,909     $ 14,489     $ 194,291  
                                           
Roger P. Deschenes (6)
Vice President, Finance and
Chief Financial Officer
2010
  $ 159,462     $ -     $ 13,288     $ 1,226     $ 173,976  
 
2009
  $ 129,615     $ 52,000     $ 10,189     $ 571     $ 192,375  
                                           
Brenda L. Baron (7)
Vice President, Manufacturing
and Technical Services
2010
  $ 129,036     $ -     $ 7,592     $ 1,051     $ 137,679  
 
2009
  $ 92,150     $ 27,500     $ 9,829     $ 850     $ 130,329  
 
                                         
 
(1)  
The amount reported in this column for the Named Executive Officer represents the dollar amount recognized for financial statement reporting purposes in fiscal 2010, determined in accordance with Accounting Standards Codification ("ASC") 718-11-25 Compensation - Stock Compensation.  See Note 2 of Notes to Consolidated Financial Statements set forth in our Annual Report on Form 10-K for fiscal year 2010 for the assumptions used in determining the value of such awards. For the fiscal year ended June 30, 2010, no option awards were granted to the Chief Executive Officer or the named executives, with the exception of Mr. Bower who received an option award exercisable into 75,000 shares of our common stock, pursuant to our 2004 Stock Option Plan.
 


 
 
 
-46-

 


(2)  
All other compensation includes, but is not limited to, premiums paid by us for disability and group term life insurance for the chief executive officer and all named executive officers; and consulting fees paid to the Mr. Bower, as noted in the following table:
 
   
Consulting Fees
   
Disability and Group Term Life Insurance Premiums
   
Vehicle Allowance
   
Moving Allowance
   
Key Man Life Insurance
   
Legal Fees
   
Total
 
                                           
Fiscal Year 2010
                                         
                                           
Named Executive Officers
                                         
Glenn D. Bolduc
  $ -     $ 1,428     $ 7,200     $ -     $ 3,318     $ 462     $ 12,408  
Bruce R. Bower
    169,800       -       -       -       -       -       169,800  
Todd A. Silvestri
    -       507       -       5,719       -       -       6,225  
Roger P. Deschenes
    -       1,226       -       -       -       -       1,226  
Brenda L. Baron
    -       1,051       -       -       -       -       1,051  
                                                         
Fiscal Year 2009
                                                       
                                                         
Named Executive Officers
                                                       
Glenn D. Bolduc
  $ -     $ 1,428     $ 3,600     $ -     $ -     $ 4,764     $ 9,792  
Bruce R. Bower
    55,200       -       -       -       -       -       55,200  
Todd A. Silvestri
    -       994       -       13,495       -       -       14,489  
Roger P. Deschenes
    -       571       -       -       -       -       571  
Brenda L. Baron
    -       850       -       -       -       -       850  


(3)  
Our Board of Directors named Mr. Glenn D. Bolduc Chief Financial Officer on July 8, 2008.  On January 1, 2009, our Board of Director’s promoted Mr. Bolduc to the position of President, Chief Executive Officer and Chief Financial Officer.  We entered into a three-year employment agreement with Mr. Bolduc  pursuant to which Mr. Bolduc receives an initial base salary of $275,000, as further described below in the Employment Agreements; Change in Control and Severance Provisions section.
 
(4)  
Mr. Bruce R. Bower joined us on August 2, 2010.
 
(5)  
Mr. Todd A. Silvestri joined us on September 8, 2008.
 
(6)  
Mr. Roger P. Deschenes was promoted to Vice President, Finance on January 5, 2009 and to Chief Financial Officer on July 5, 2010.
 
(7)  
Ms. Brenda L. Baron was promoted to Vice President, Manufacturing and Technical Services on February 5, 2009.
 
Employment Agreements; Change in Control and Severance Provisions
 
Terms of Employment Agreement with Named Executive Officers
 
On February 6, 2009, we entered into a three-year employment agreement with Mr. Glenn D. Bolduc, President, Chief Executive Officer and Chief Financial Officer, pursuant to which Mr. Bolduc receives an initial base salary of $275,000 per year, commencing as of January 1, 2009.  The base salary thereafter shall be subject to annual review and adjustment, as determined by the Board in its sole discretion. In July, 2010, the Compensation Committee of the Board of Directors approved an increase in Mr. Bolduc’s annual base salary to $325,000. After the third year, the agreement will automatically renew for additional one-year periods unless notice of non-renewal is given by either party.  The agreement also provides for Mr. Bolduc to be eligible to receive incentive compensation in an amount of up to $137,000 for the fiscal year ending June 30, 2009, upon the achievement of certain performance milestones established by the Board of Directors, “key man” life insurance and a car allowance.  Incentive compensation, if any, for subsequent fiscal years will be based on performance milestones to be established by mutual agreement between Mr. Bolduc and us within 60 days after the commencement of each such fiscal year. For the fiscal year ended June 30, 2010, the Board of Directors determined that Mr. Bolduc was not eligible to receive incentive compensation.
 


 
 
 
-47-

 


 
In connection with his employment agreement, Mr. Bolduc has been granted an incentive option under the our 2004 Stock Option Plan to purchase 680,000 shares of our common stock at an exercise price of $.17 per share.  The option vests in equal annual installments over a three-year period commencing on January 1, 2010.  These options were valued using the Black-Scholes method, using the following assumptions: volatility 99.0%, risk-free interest rate 1.52%, expected life of six years and expected dividend yield of 0.0%.
 
In addition, Mr. Bolduc may participate in our employee fringe benefit programs or programs readily available to employees of comparable status and position. We may terminate his employment for any material breach of this employment agreement at any time.  In the event Mr. Bolduc’s employment is terminated by us without “cause” or Mr. Bolduc resigns for “good reason” (as those terms are defined in the agreement), we will pay him twelve months salary on a regular payroll basis and a pro rata portion of any bonus compensation earned during the year of termination, as well as the continuation of certain benefits as separation payments.  Under his employment agreement, Mr. Bolduc is subject to restrictive covenants, including confidentiality provisions and a one year non-compete and non-solicitation provision.
 
For the purpose of Mr. Bolduc’s employment agreement, “Good Reason”  means, without Mr. Bolduc’s written consent, (a) a material diminution of duties assigned to Mr. Bolduc; (b) a material reduction in Base Salary or other benefits (other than a reduction or change in benefits generally applicable to all executive employees of the Company); (c) relocation to an office more than fifty miles outside the Company’s current location in the greater Boston area: (d) a change in control of the Company, as defined: or, (e) the acquisition by any individual, entity or group of 50% or more of the then outstanding shares of voting stock (the “Voting Stock”) of the Company, provided, however, that any acquisition by the Company or its subsidiaries, or any employee benefit plan (or related trust) of the Company or its subsidiaries of (i) 50% or more of the then outstanding Voting Stock, or (ii) Voting Stock which has the effect of increasing the percentage of Voting Stock owned by any individual, entity or group to 50% or more of the then outstanding Voting Stock, shall not constitute a change in control.  Notwithstanding the occurrence of any of the aforementioned events, no event or condition shall be deemed to constitute Good Reason unless (i)  Mr. Bolduc reports the event or condition which he believes to be Good Reason to the Board of Directors, in writing, within 45 days of such event or condition occurring and (ii) within 30 days after Mr. Bolduc provides such written notice of Good Reason, the Company has failed to fully correct such Good Reason and to make him whole for any such losses.
 
For the purpose of Mr. Bolduc’s employment agreement, “Cause” means any of the following:
 
·  
conviction or entry of nolo contendere to any felony or a crime involving moral turpitude, fraud or embezzlement of Company property;
 
·  
dishonesty, gross negligence or gross misconduct that is materially injurious to the Company or material breach of his or her duties, which has not been cured by Mr. Bolduc  within 10 days (or longer period as is reasonably required to cure such breach, negligence or misconduct) after she shall have received written notice from the Company stating with reasonable specificity the nature of such breach; and
 
·  
illegal use or abuse of drugs, alcohol, or other related substances that is materially injurious to the Company.
 


 
 
 
-48-

 


Potential Payments Upon Termination or Change in Control
 
The following table describes the estimated incremental compensation upon (i) termination by the Company of the Mr. Bolduc without Cause, or (ii) termination for Good Reason by Mr. Bolduc .  The estimated incremental compensation assumes the triggering event had occurred on June 30, 2010.  Benefits generally available to all employees are not included in the table.  The actual amount of compensation can only be determined at the time of termination or change in control.

 
 
Base Salary Continuation (1)
   
COBRA Premiums (2)
   
Life Insurance Premiums (3)
   
Other
 
Glenn D. Bolduc
  $ 325,000     $ 13,204     $ 1,428     $ -  
 
(1)  
We shall continue to pay Mr. Bolduc’s annual base salary then in effect for twelve (12) months on a regular payroll basis.
 
(2)  
Represents estimated out-of-pocket COBRA health insurance premium expenses to be paid by us on behalf of Mr. Bolduc after termination.   Estimated out-of-pocket COBRA health insurance premium incurred by Mr. Bolduc over the 12 month period following termination to be reimbursed by us .  Currently, Mr. Bolduc does not subscribe to health benefits provided by us.
 
(3)  
Represents estimated life insurance premiums to be paid by us on behalf of Mr. Bolduc after termination.  We shall continue in full force and effect, at our expense, the life insurance benefits provided in Mr. Bolduc’s Employment Agreement for a period of 12 months after termination of Mr. Bolduc’s employment or until Mr. Bolduc becomes employed, whichever occurs first.
 


 
 
 
-49-

 


Outstanding Equity Awards at 2010 Fiscal Year-End
 
The following table provides information regarding outstanding stock options held by each Named Executive Officer as of the fiscal year ended June 30, 2010.
 
Named Executive Officers
       
Number of Securities Underlying Unexercised Options Exercisable
   
Number of Securities Underlying Unexercised Options Unexercisable
   
Option Exercise Price ($)
 
Option Expiration Date
Glenn D. Bolduc
     (1 )     39,890       30,110     $ 0.20  
12/30/2018
       (2 )     33,333       66,667     $ 0.20  
12/30/2018
       (3 )     226,667       453,333     $ 0.17  
01/01/2019
            299,890       550,110            
                                 
Bruce R. Bower
     (4 )     25,000       50,000     $ 0.12  
03/02/2014
       (5 )     -       75,000     $ 0.52  
05/07/2015
            25,000       125,000            
                                 
Todd A. Silvestri
     (6 )     13,801       11,199     $ 0.20  
12/30/2013
       (7 )     25,000       50,000     $ 0.17  
02/05/2014
       (8 )     16,667       33,333     $ 0.10  
06/30/2014
            55,468       94,532            
Roger P. Deschenes
     (9 )     14,598       10,402     $ 0.20  
12/30/2013
       (7 )     25,000       50,000     $ 0.17  
02/05/2019
       (8 )     33,333       66,667     $ 0.10  
06/30/2019
            72,931       127,069            
                                 
Brenda L. Baron
   (10 )     15,808       6,692     $ 0.20  
12/30/2013
       (7 )     25,833       51,667     $ 0.17  
02/05/2014
       (8 )     16,667       33,333     $ 0.10  
06/30/2014
            58,308       91,692            
            511,597       988,403            
 
(1)  
Exercisable in installments of 9,780 shares, 30,110 shares, and 30,110 shares on December 30, 2008, December 30, 2009, and December 30, 2010, respectively.
 
(2)  
Exercisable in three equal annual installments commencing December 30, 2009.
 
(3)  
Exercisable in three equal annual installments commencing January 1, 2010.
 
(4)  
Exercisable in three equal annual installments commencing March 2, 2010.
 
(5)  
Exercisable in three equal annual installments commencing May 7, 2011.
 
(6)  
Exercisable in installments of 2,602 shares, 11,199 shares, and 11,199 shares on December 30, 2008, December 30, 2009, and December 30, 2010, respectively.
 
(7)  
Exercisable in three equal annual installments commencing February 5, 2010.
 
(8)  
Exercisable in three equal annual installments commencing June 30, 2010.
 
(9)  
Exercisable in installments of 4,196 shares, 10,402 shares, and 10,402 shares on December 30, 2008, December 30, 2009, and December 30, 2010, respectively.
 
(10)  
Exercisable in installments of 9,116 shares, 6,692 shares, and 6,692 shares on December 30, 2008, December 30, 2009, and December 30, 2010, respectively.

 


 
 
 
-50-

 


2010 Option Exercises and Stock Vested
 
During the year ended June 30, 2010, there were no exercises of option awards by any of the Named Executive Officers.
 
Directors’ Compensation
 
The following table sets forth the annual compensation of our non-employee directors for fiscal 2010, which consisted of annual cash retainers, board and committee meeting fees and equity awards in the form of options pursuant to the 2000 Incentive and Non-Qualified Stock Option Plan, and the 2004 Stock Option Plan.  Employee directors do not receive any separate compensation for their service on the Board.

Name
 
Fees Earned or Paid in Cash
($)
   
Option Awards
($) (1)
   
All Other Compensation
($) (2)
   
Total
($)
 
John A. Keating
  $ 28,000     $ 11,818     $ -     $ 39,818  
Joseph E. Levangie (3)
    46,950       -       -       46,950  
Robert P. Liscouski
    29,000       11,818       10,000       50,818  
Howard Safir
    30,850       11,818       -       42,668  
Michael C. Turmelle (3)
    46,950       -       -       46,950  
 
(1)  
The amount reported in this column for the non-employee director represents the dollar amount recognized for financial statement reporting purposes in fiscal 2010, determined in accordance with Statement of Accounting Standards Codification ("ASC") 718-10-25 Compensation - Stock Compensation.  See Note 2 of Notes to Consolidated Financial Statements set forth in the Company’s Annual Report on Form 10-K for fiscal year 2010 for the assumptions used in determining the value of such awards.  For the fiscal year ended June 30, 2010, no option awards were granted to our non-employee directors.
 
(2)  
Mr. Liscouski received $10,000 of other compensation for consulting services provided to us including attendance at meetings with agencies of the U.S. government.
 
(3)  
Messrs. Levangie and Turmelle each received retroactive retainers of $10,000 in the fiscal year ended June 30, 2010 due to increased responsibilities discharged by each director as a result of vacancies which existed on the board of directors from January 2009 through May 2009.
 
Additional Information to Understand the Director Compensation Table
 
Effective July 1, 2009, fees paid to our non-employee directors in connection with their service as a director are as follows: $20,000 annual retainer to each director; $1,000 for each Board of Directors meeting attended;   $750 for each committee meeting attended: and $500 for each Board of Directors meeting or committee meeting in which the director participates by telephone conference call.
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
Information related to securities authorized for issuance under equity compensation plans as of the end of fiscal 2010 is included in Item 5 of Part II of the Company’s Annual Report of Form 10-K for the year ended June 30, 2010.
 
The following table sets forth the beneficial ownership of shares of our common stock, as of September 30, 2010, of (i) each person known by us to beneficially own five percent (5%) or more of such shares; (ii) each of our directors and executive officers named in the Summary Compensation Table; and (iii) all of our current executive officers, directors, and significant employees as a group.  Except as otherwise indicated, all shares are beneficially owned, and the persons named as owners hold investment and voting power.
 


 
 
 
-51-

 


Beneficial ownership has been determined in accordance with Rule 13d-3 under the Securities Exchange Act of 1934.  Under this rule, certain shares may be deemed to be beneficially owned by more than one person, if, for example, persons share the power to vote or the power to dispose of the shares.  In addition, shares are deemed to be beneficially owned by a person if the person has the right to acquire shares, for example, upon exercise of an option or warrant, within sixty (60) days of September 30, 2010.  In computing the percentage ownership of any person, the amount of shares is deemed to include the amount of shares beneficially owned by such person, and only such person, by reason of such acquisition rights.  As a result, the percentage of outstanding shares of any person as shown in the following table does not necessarily reflect the person’s actual voting power at any particular date.

   
Amount and Nature
   
Percentage
 
Name and Address of Beneficial Owner (1)
 
of Beneficial Ownership
   
of Class (2)
 
Executive Officers and Directors
           
Brenda L. Baron (3)
    58,308       *  
Glenn D. Bolduc (4)
    299,890       1.1 %
Bruce R. Bower (5)
    25,000       *  
Roger P. Deschenes (6)
    72,931       *  
Todd A. Silvestri (7)
    55,468       *  
John A. Keating (8)
    200,000       *  
Joseph E. Levangie (9)
    230,000       *  
Robert P, Liscouski (10)
    200,000       *  
Howard Safir (11)
    200,000       *  
Michael C. Turmelle (12)
    1,490,000       5.7 %
                 
All Executive Officers and Directors as a group (10 persons) (13)
    2,831,597       10.3 %
 
*      Less than 1%
 
(1)  
Unless otherwise indicated, the business address of the stockholders named in the table above is Implant Sciences Corporation, 600 Research Drive, Wilmington, MA 01887.
 
(2)  
Based on 25,886,615 outstanding shares as of September 30, 2010.
 
(3)  
Includes 58,308 shares of common stock, which may be purchased within sixty (60) days of September 30, 2010 upon the exercise of stock options.
 
(4)  
Includes 299,890 shares of common stock, which may be purchased within sixty (60) days of September 30, 2010 upon the exercise of stock options.
 
(5)  
Includes 25,000 shares of common stock, which may be purchased within sixty (60) days of September 30, 2010 upon the exercise of stock options.
 
(6)  
Includes 72,931 shares of common stock, which may be purchased within sixty (60) days of September 30, 2010 upon the exercise of stock options.
 
(7)  
Includes 55,468 shares of common stock, which may be purchased within sixty (60) days of September 30, 2010 upon the exercise of stock options.
 
(8)  
Includes 200,000 shares of common stock, which may be purchased within sixty (60) days of September 30, 2010 upon the exercise of stock options.
 
(9)  
Includes 230,000 shares of common stock, which may be purchased within sixty (60) days of September 30, 2010 upon the exercise of stock options.
 
(10)  
Includes 200,000 shares of common stock, which may be purchased within sixty (60) days of September 30, 2010 upon the exercise of stock options.
 
(11)  
Includes 200,000 shares of common stock, which may be purchased within sixty (60) days of September 30, 2010 upon the exercise of stock options.
 
(12)  
Includes 240,000 shares of common stock, which may be purchased within sixty (60) days of September 30, 2008 upon the exercise of stock options.
 
(13)  
See footnotes (3) through (12).
 

 


 
 
 
-52-

 


Item 13.
Certain Relationships and Related Transactions, and Director Independence
 
Transactions with related parties, including, but not limited to, members of the Board of Directors, are reviewed and approved by all members of the Board of Directors.  In the event a transaction with a member of the Board is contemplated, the Director having a beneficial interest in the transaction is not allowed to participate in the decision-making and approval process.  The policies and procedures surrounding the review, approval or ratification of related party transactions are not in writing, nevertheless, such reviews, approvals and ratifications of related party transactions are documented in the minutes of the meetings of the Board of Directors and any such transactions are committed to writing between the related party and the Company in an executed engagement agreement.
 
Robert Liscouski, a member of our Board of Directors, serves as the head of strategic and business development programs at Secure Strategy Group, a homeland security-focused banking and strategic advisory firm that has been retained by us to assist with our efforts to acquire additional capital.  During years ended June 30, 2010 and 2009, this advisory firm was paid $181,000 and $25,000, respectively.  As of June 30, 2010, our obligation to Secure Strategy Group was $15,000.
 
On June 4, 2009, Michael Turmelle, a member of the Board of Directors of the Company loaned $100,000 to the Company. See Note 13 of Notes to Consolidated Financial Statements. In July 2010, Michael Turmelle, elected to convert $100,000 of the entire principal amount owed by us under the promissory note into 1,250,000 shares of our common stock, at a conversion price of $0.08 per share, and valued at $462,500 on the date of conversion.
 
Independence of the Board of Directors
 
The Board of Directors has adopted director independence guidelines that are consistent with the definitions of “independence” as set forth in Section 301 of the Sarbanes-Oxley Act of 2002 and Rule 10A-3 under the Securities Exchange Act of 1934.  In accordance with these guidelines, the Board of Directors has reviewed and considered facts and circumstances relevant to the independence of each of our directors and director nominees and has determined that, each of the Company’s non-management directors qualifies as “independent.”
 
Item 14.
Principal Accounting Fees and Services
 
On April 19, 2010, UHY LLP (“UHY”), our independent registered public accounting firm, informed us that, effective April 16, 2010, its New England practice was acquired by Marcum LLP. As a result of this transaction, UHY also informed us that it had resigned as our independent registered public accounting firm effective as of April 19, 2010. UHY audited our financial statements for the fiscal years ended June 30, 2009 and 2008.
 
The Audit Committee of our Board of Directors has appointed Marcum LLP as our independent registered public accounting firm effective April 21, 2010. The firm of Marcum LLP (“Marcum”) acts as our principal independent registered public accounting firm.
 
The following is a summary of the fees billed to us by Marcum LLP, our independent registered public accounting firm; and UHY LLP, our predecessor independent registered public accounting firm, for professional services rendered for the fiscal years ended June 30, 2010 and 2009.  The Audit Committee considered and discussed with both Marcum LLP and UHY LLP the provision of non-audit services to us and the compatibility of providing such services with maintaining their independence as our auditors.
 
Fee Category
 
Years Ended June 30,
 
   
2010
   
2009
 
Audit fees - UHY LLP
  $ 61,000     $ 281,000  
Audit fees - Marcum LLP
    145,000       -  
Audit-related fees
    20,000       8,000  
Tax fees
    -       -  
All other fees
    1,000       1,000  
Total fees
  $ 227,000     $ 290,000  
 
Audit Fees.  Consist of fees billed for professional services rendered for the audit of our annual financial statements and review of financial statements included in our quarterly reports and other professional services provided in connection with regulatory filings.
 
Audit-Related Fees.  Consist of fees billed for assurance and related services that related to the performance of the audit or review of our financial statements and are not otherwise reported under “Audit Fees”.
 


 
 
 
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Tax Fees.  Consist of fees billed for professional services for tax compliance, tax advice and tax planning.  These services include assistance regarding federal and state tax compliance and acquisitions.
 
Pre-Approval Policies and Procedures.  The Audit Committee has the authority to approve all audit and non-audit services that are to be performed by the Company’s independent registered public accounting firm.  Generally, the Company may not engage its independent registered public accounting firm to render audit or non-audit services unless the service is specifically approved in advance by the Audit Committee (or a properly delegated subcommittee thereof).  All Audit-related fees, Tax fees and All other fees were approved by the Audit Committee.
 
All Other Fees.  Consist of fees billed for professional services other than those fees described above.
 


 
 
 
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PART IV
 
Item 15.
Exhibits, Financial Statement Schedules
 
 
The following are filed as part of this Form 10-K:
 
 
(1)
Financial Statements: For a list of financial statements which are filed as part of this Annual Report on Form 10-K, See Page 31.
 
 
(2)
Exhibits
 
Exhibit No.
Ref. No.
Description
     
2.1
1
Agreement and Plan of Merger and Reorganization, dated April 10, 2008, by and among Implant Sciences Corporation, IMX Acquisition Corp., Ion Metrics, Inc., all shareholders of Ion Metrics, Inc. and David J. Ferran, as Shareholder Representative.
2.2
2
Asset Purchase Agreement, dated June 27, 2008, between Implant Sciences Corporation and International Brachytherapy, s.a.
2.3
2
Xenation License Agreement and related Security Agreement, each dated June 30, 2008, between Implant Sciences Corporation and International Brachytherapy, s.a.
2.4
2
Ytterbium License Agreement and related Security Agreement, each dated June 30, 2008, between Implant Sciences Corporation and International Brachytherapy, s.a.
2.5
3
Asset Purchase Agreement, dated July 18, 2008, between Implant Sciences Corporation and Best Medical International, Inc.
2.6
4
Asset Purchase Agreement, dated November 14, 2008, by and among Core Systems Incorporated, C Acquisition Corp. and Implant Sciences Corporation.
2.7
5
Amendment dated November 24, 2008, to Asset Purchase Agreement dated November 14, 2008, by and among Implant Sciences Corporation, C Acquisition Corp. and Core Systems Incorporated.
2.8
5
Promissory Note, dated November 24, 2008, in the principal amount of $1,625,000, executed by Core Systems Incorporated and delivered to C Acquisition Corp.
2.9
5
 Security Agreement, dated November 24, 2008, between Core Systems Incorporated and C Acquisition Corp.
3.1
6
Restated Articles of Organization, as amended, of Implant Sciences Corporation.
3.2
7
Amended and Restated By-Law, as amended, of Implant Sciences Corporation.
4.1
8
Specimen certificate for the Common Stock of Implant Sciences Corporation.
10.1
9
1992 Stock Option Plan.
10.2
9
Form of Stock Option Agreement under the 1992 Stock Option Plan.
10.3
9
1998 Incentive and Nonqualified Stock Option Plan.
10.4
8
Form of Incentive Stock Option under the 1998 Incentive and Nonqualified Stock Option Plan.
10.5
8
Form of Nonqualified Stock Option under the 1998 Incentive and Nonqualified Stock Option Plan.
10.6
8
Form of Nonqualified Stock Option for Non-Employee Directors under the 1998 Incentive and Nonqualified Stock Option Plan.
10.7
10
2000 Incentive and Non-Qualified Stock Option Plan of Implant Sciences Corporation.
10.8
11
2004 Stock Option Plan of Implant Sciences Corporation.
10.9
12
2006 Employee Stock Purchase Plan of Implant Sciences Corporation.
10.10
13
Employment Agreement, dated June 30, 2004, between Implant Sciences Corporation and Anthony J. Armini.
10.11
14
Transition Agreement, dated as of September 27, 2007, between Implant Sciences Corporation and Dr. Anthony J. Armini.
10.12
15
Amendment, dated November 4, 2008, to the Transition Agreement dated as of September 27, 2007, between Implant Sciences Corporation and Dr. Anthony J. Armini.


 
 
 
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10.13
16
Employment Agreement, dated as of July 31, 2008, by and between Implant Sciences Corporation and Glenn D. Bolduc.
10.14
17
Employment Agreement, dated as of February 6, 2009, between Implant Sciences Corporation and Glenn D. Bolduc.
10.15
18
Lease, dated December 11, 2008, between Implant Sciences Corporation and Wakefield Investments, Inc.
10.16
19*
Development, Distribution and Manufacturing Agreement, dated March 23, 2005 by and between Implant Sciences Corporation and Rapiscan Systems, Inc.
10.17
20
Agreement, dated January 4, 2008, between the Implant Sciences Corporation, OSI Systems, Inc. and Rapiscan Systems, Inc.
10.18
21
Form of Securities Purchase Agreement, dated as of June 17, 2004, among Implant Sciences and certain investors.
10.19
21
Form of Common Stock Purchase Warrant, dated June 17, 2004, issued by Implant Sciences Corporation to certain investors.
10.20
21
Form of Additional Investment Right, dated June 17, 2004 among Implant Sciences Corporation and certain investors.
10.21
21
Form of Registration Rights Agreement, dated June 17, 2004 among Implant Sciences Corporation and certain investors.
10.22
22
Form of Securities Purchase Agreement, dated March 3, 2005, by and between Implant Sciences Corporation and certain investors.
10.23
23
Form of Common Stock Purchase Warrant, issued by Implant Sciences Corporation to certain investors.
10.24
23
Form of Common Stock Purchase Warrant, dated March 4, 2005, issued by Implant Sciences Corporation to PacificWave Partners Limited.
10.25
23
Form of Additional Investment Right, dated March 4, 2005, among Implant Sciences Corporation and certain investors.
10.26
23
Form of Registration Rights Agreement, dated March 4, 2005, among Implant Sciences Corporation and certain investors.
10.27
24
Common Stock Purchase Warrant, dated January 3, 2007, issued by Implant Sciences Corporation to Bridge Bank, N.A.
10.28
25
Form of Common Stock Purchase Warrant, dated July 6, 2005, issued by Implant Sciences Corporation to Laurus Master Fund, Ltd.
10.29
26
Registration Rights Agreement, dated as of September 30, 2005, by and between Implant Sciences Corporation and Laurus Master Fund, Ltd.
10.30
26
Common Stock Purchase Warrant, dated September 30, 2005, issued by Implant Sciences Corporation to Laurus Master Fund, Ltd.
10.31
27
Form of Common Stock Purchase Warrant, dated May 31, 2006, issued by Implant Sciences Corporation to Laurus Master Fund, Ltd.
10.32
24
Common Stock Purchase Warrant, dated December 29, 2006, issued by Implant Sciences Corporation to Laurus Master Fund, Ltd.
10.33
28
Omnibus Amendment, dated as of September 30, 2008, among Implant Sciences Corporation and LV Administrative Services, Inc. as administrative and collateral agent for each of Laurus Master Fund, Ltd. and Valens Offshore SPV I, Ltd., to (i) the Securities Purchase Agreement, dated as of September 29, 2005, by and between Implant Sciences Corporation and Laurus Master Fund, Ltd. and (ii) certain the other related agreements referred to in such securities purchase agreement.
10.34
15
Omnibus Amendment, dated as of October 31, 2008, among Implant Sciences Corporation and LV Administrative Services, Inc., as administrative and collateral agent for each of Laurus Master Fund, Ltd. and Valens Offshore SPV I, Ltd., to (i) that certain Securities Purchase Agreement, dated as of September 29, 2005, by and between Implant Sciences Corporation and Laurus Master Fund, Ltd. and (ii) certain the other related agreements referred to in such securities purchase agreement.


 
 
 
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10.35
29
Common Stock Purchase Warrant, dated October 7, 2002, issued by Implant Sciences Corporation to Laurus Master Fund, Ltd.
10.36
30
Common Stock Purchase Warrant, dated August 28, 2003, issued by Implant Sciences Corporation to Laurus Master Fund, Ltd.
10.37
31
Common Stock Purchase Warrant, dated November 25, 2003, issued by Implant Sciences
Corporation to Laurus Master Fund, Ltd.
10.38
32
Note and Warrant Purchase Agreement, dated as of December 10, 2008, between Implant Sciences Corporation and DMRJ Group LLC.
10.39
32
Senior Secured Convertible Promissory Note, dated December 10, 2008, in the principal amount of $5,600,000, issued by Implant Sciences Corporation to DMRJ Group LLC
10.40
32
Warrant to Purchase Shares of Common Stock, dated December 10, 2008, issued by Implant Sciences Corporation to DMRJ Group LLC.
10.41
32
Security Agreement, dated as of December 10, 2008, among Implant Sciences Corporation, C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp., as grantors, and DMRJ Group LLC, as secured party.
10.42
32
Patent Security Agreement, dated as of December 10, 2008, among Implant Sciences Corporation, C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp., as grantors, and DMRJ Group LLC, as secured party.
10.43
32
Guaranty, dated as of December 10, 2008, of the obligations of Implant Sciences Corporation by C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp. in favor of DMRJ Group LLC.
10.44
33
Letter Agreement, dated as of March 12, 2009, between Implant Sciences Corporation and DMRJ Group LLC.
10.45
33
Amended and Restated Senior Secured Convertible Promissory Note, dated December 10, 2008, in the principal amount of $5,600,000, issued by Implant Sciences Corporation to DMRJ Group LLC.
10.46
33
Amended and Restated Warrant to Purchase Shares of Common Stock, dated March 12, 2009, issued by Implant Sciences Corporation to DMRJ Group LLC.
10.47
34
First Amendment, dated July 1, 2009, to Note and Warrant Purchase Agreement, dated as of December 10, 2008, between Implant Sciences Corporation and DMRJ Group LLC.
10.48
34
Senior Secured Promissory Note, dated July 1, 2009, in the principal amount of $1,000,000, issued by Implant Sciences Corporation to DMRJ Group LLC.
10.49
35
Credit Amendment, dated September 4, 2009, among Implant Sciences Corporation, C Acquisition Corp., Accurel Systems International Corporation, IMX Acquisition Corp. and DMRJ Group LLC.
10.50
35
Promissory Note, dated September 4, 2009, in the maximum principal amount of $3,000,000, issued by Implant Sciences Corporation to DMRJ Group LLC.
10.51
35
Security Agreement, dated as of September 4, 2009, among Implant Sciences Corporation, C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp., as grantors, and DMRJ Group LLC, as secured part
10.52
35
Patent Security Agreement, dated as of September 4, 2009, among Implant Sciences Corporation, C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp., as grantors, and DMRJ Group LLC, as secured party.
10.53
35
Guaranty, dated as of September 4, 2009, of the obligations of Implant Sciences Corporation by C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp. in favor of DMRJ Group LLC.
10.54
36
Omnibus Waiver and First Amendment to Credit Agreement and Third Amendment to Note and Warrant Purchase Agreement, dated as of January 12, 2010 between Implant Sciences Corporation and DMRJ Group LLC.
10.55
36
Amended and Restated Promissory Note, dated as of January 12, 2010.


 
 
 
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10.56
37
Omnibus Second Amendment to Credit Agreement and Fourth Amendment to Note and       Warrant Purchase Agreement, dated as of April 23, 2010 between Implant Sciences Corporation and DMRJ Group LLC.
10.57
37
Amended and Restated Promissory Note, dated as of April 23, 2010.
10.58
38
Convertible Promissory Note, dated November 11, 2009 issued to Michael C. Turmelle.
10.59
39
Omnibus Third Amendment to Credit Agreement and Fifth Amendment to Note and Warrant Purchase Agreement, dated as of September 30, 2010 between Implant Sciences Corporation and DMRJ Group LLC.
10.60
 
Lease, dated February 1, 2010, between Implant Sciences Corporation and Wakefield Investments, Inc.
21.1
 
Subsidiaries of Implant Sciences Corporation.
23.1
 
Consent of Marcum LLP.
23.2   Consent of UHY 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.

 
1
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated April 10, 2008 and filed on April 16, 2008, and incorporated herein by reference.
 
2
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated June 27, 2008 and filed on July 9, 2008 and incorporated herein by reference.
 
3
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated July 18, 2008 and filed July 24, 2008, and incorporated herein by reference.
 
4
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated November 14, 2008 and filed November 19, 2008, and incorporated herein by reference.
 
5
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated November 24, 2008 and filed December 1, 2008, and incorporated herein by reference.
 
6
Filed as an Exhibit to Implant Sciences Corporation’s Annual Report on Form 10-K for the fiscal year ended June 30, 2009, and incorporated herein by reference.
 
7
Filed as an  Exhibit to Implant Sciences Corporation’s Form 8-K dated December 12, 2007 and filed December 18, 2007, and incorporated herein by reference.
 
8
Filed as an Exhibit to Amendment No. 1 to Implant Sciences Corporation’s Registration Statement on Form SB-2 (Registration No. 333-64499), filed on December 21, 1998, and incorporated herein by reference.
 
9
Filed as an Exhibit to Implant Sciences Corporation’s Registration Statement on Form SB-2 (Registration No. 333-64499), filed on September 29, 1998, and incorporated herein by reference.
 
10
Filed as an Exhibit to Implant Sciences Corporation’s Registration Statement on Form S-8, filed on December 12, 2003, and incorporated herein by reference.
 
11
Filed as an Exhibit to Implant Sciences Corporation’s Registration Statement on Form S-8, filed on October 30, 2006, and incorporated herein by reference.
 
12
Filed as an Exhibit to Implant Sciences Corporation’s Registration Statement on Form S-8, filed on July 26, 2007, and incorporated herein by reference.
 
13
Filed as an Exhibit to Implant Sciences Corporation’s Annual Report on Form 10-KSB for the fiscal year ended June 30, 2004, and incorporated herein by reference.
 
14
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated September 27, 2007 and filed on October 3, 2007, and incorporated herein by reference.


 
 
 
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15
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated November 4, 2008 and filed on November 6, 2008, and incorporated herein by reference.
 
16
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated July 31, 2008 and filed on August 4, 2008, and incorporated herein by reference.
 
17
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated February 6, 2009 and filed on February 11, 2009, and incorporated herein by reference.
 
18
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated December 11, 2008 and filed on December 17, 2008, and incorporated herein by reference.
 
19
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K/A dated March 23, 2005 and filed on April 7, 2005, and incorporated herein by reference.
 
20
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated January 4, 2008 and file on January 10, 2008, and incorporated herein by reference.
 
21
Filed as an Exhibit to Implant Sciences Corporation’s Registration Statement on Form S-3, filed on July 14, 2004, and incorporated herein by reference.
 
22
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K/A dated March 4, 2005 and filed on March 9, 2005, and incorporated herein by reference.
 
23
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated March 4, 2005 and filed on March 9, 2005, and incorporated herein by reference.
 
24
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated December 29, 2006 and filed on January 8, 2007, and incorporated herein by reference.
 
25
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated July 8, 2005 and filed on July 14, 2005, and incorporated herein by reference.
 
26
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated September 30, 2005 and filed on October 5, 2005, and incorporated herein by reference.
 
27
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated May 31, 2006 and filed on June 6, 2006, and incorporated herein by reference.
 
28
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated October 3, 2008 and filed on October 6, 2008, and incorporated herein by reference.
 
29
Filed as an Exhibit to Implant Sciences Corporation’s Annual Report on Form 10-KSB for the fiscal year ended June 30, 2002, and incorporated herein by reference.
 
30
Filed as an Exhibit to Implant Sciences Corporation’s Annual Report on Form 10-KSB for the fiscal year ended June 30, 2003, and incorporated herein by reference.
 
31
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated December 10, 2003 and filed on December 12, 2003, and incorporated herein by reference.
 
32
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated December 10, 2008 and filed December 16, 2008, and incorporated herein by reference.
 
33
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated March 12, 2009 and filed March 18, 2009, and incorporated herein by reference.
 
34
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated July 1, 2009 and filed July 8, 2009, and incorporated herein by reference.
 
35
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated September 4, 2009 and filed September 11, 2009, and incorporated herein by reference.
 
36
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated January 13, 2010 and filed January 14, 2010, and incorporated herein by reference.