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  • 10-Q (Feb 14, 2014)
  • 10-Q (Nov 14, 2013)
  • 10-Q (May 17, 2013)
  • 10-Q (Feb 14, 2013)
  • 10-Q (Nov 20, 2012)
  • 10-Q (Nov 14, 2012)

 
8-K

 
Other

Implant Sciences 10-Q 2011

Documents found in this filing:

  1. 10-Q/A
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
imsc10qa_100331.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q/A
(Amendment No. 1)
 
(Mark One)
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2010                                                                                                                                          
 
or
 
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                                                                                      to                                                      
 
Commission File Number: 001-14949                                                                                                                                          
 

 
Implant Sciences Corporation
(Exact name of registrant as specified in our charter)
 
Massachusetts
(State or other jurisdiction of
incorporation or organization)
 
04-2837126
(I.R.S. Employer Identification No.)
 
 
600 Research Drive, Wilmington, Massachusetts
(Address of principal executive offices)
 
 
01887
(Zip Code)

 
(978) 752-1700
(Registrant’s telephone number, including area code)

 (Former name, former address and former fiscal year, if changed since last report)
 


 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes x  No q
 
Indicate by check mark whether the registrant has submitted electronically and posted on our 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 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 Exchange Act.  (Check one):
 
q  Large Accelerated Filer                                                                                                           q  Accelerated Filer
 
q  Non-accelerated Filer                                                                                                           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 May 10, 2010, there were 24,624,195 shares of the registrant’s Common Stock outstanding.
 

 
 

 

Explanatory Note
 

 
This Amendment No.1 on Form 10-Q/A (“Amendment No. 1”) to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010, initially filed with the Securities and Exchange Commission on May 19, 2010, is being filed to restate our consolidated financial statements at, and for the three and nine months ended March 31, 2010 and the notes related thereto and the related sections of the Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Background of the Restatement
 
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 Report 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 (“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 our common stock. 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.  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.
 
On December 10, 2008, we entered into a note and warrant purchase agreement with DMRJ Group LLC, 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 promissory note and warrant were each amended and restated as of March 12, 2009. Both the promissory note and the warrant contain 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 conversion price of the promissory note and 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.  We determined that the conversion option and 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 and will record a cumulative-effect adjustment to the opening balance of accumulated deficit at July 1, 2009.
 
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 accumulated deficit.  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
 
On July 1, 2009, in connection with the issuance of the $1,000,000 senior secured promissory note, 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 issued such additional shares to DMRJ.  In accordance with Accounting Standards Codification (“ASC”) 470-20 “Debt”, a conversion feature is beneficial, or “in the money,” when the conversion rate of the convertible security is below the market price of the underlying common stock. The beneficial conversion feature is treated as a deemed dividend to the preferred shareholders.
 
See Note 3 in the Notes to Condensed Consolidated Financial Statements included in this Amendment No. 1 for a discussion of the corrections and reconciliations of amounts previously reported to those shown herein.
 

 
-2-

 

Internal Control Considerations
 
Our management identified a deficiency in 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 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, as required under Accounting Standards Codification (“ASC”) 470-20 “Debt.” 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 March 31, 2010 and further concluded that, as of such date, our disclosure controls and procedures were not effective at the reasonable assurance level.  A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.
 
For the convenience of the reader this Amendment No. 1 sets forth our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 as originally filed with the Securities and Exchange Commission on May 19, 2010, as modified where necessary to reflect the restatement.  The following items have been amended as a result of, and to reflect, the restatement:
 
·  
Part I – Item 1- Financial Information
 
·  
Part I – Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
·  
Part I – Item 4T – Control Procedures
 
·  
Part II – Item 1A – Risk Factors: and
 
·  
Part II – Item 6 Exhibits
 
This Amendment No. 1 includes certifications from our Chief Executive Officer and Chief Financial Officer dated as of the date of this filing.  The sections of our Quarterly Report on Form 10-Q, filed on May 19, 2010 which were not amended are unchanged and continue in full force and effect as originally filed.  Except for the foregoing and amended information, this Amendment No.1 continues to describe conditions as of May 19, 2010, the date we filed our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 and we have not updated the disclosures contained herein to reflect events that occurred subsequent to that date.
 


 
-3-

 

IMPLANT SCIENCES CORPORATION

TABLE OF CONTENTS






   
Page
PART I.
FINANCIAL INFORMATION
 
     
Item 1.
Condensed Consolidated Financial Statements
 
 
Condensed Consolidated Balance Sheets at March 31, 2010 (unaudited)
   and June 30, 2009
5
 
Condensed Consolidated Statements of Operations (unaudited) for
  the three and nine months ended  March 31, 2010 and 2009
 
6
 
Condensed Consolidated Statements of Cash Flows (unaudited) for
  the nine months ended  March 31, 2010 and 2009
 
7-8
 
Notes to Condensed Consolidated Financial Statements
9-39
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
40-57
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
57
Item 4T.
Controls and Procedures
57-58
     
PART II.
OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
59
Item 1A.
Risk Factors
59-60
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
60
Item 3.
Defaults Upon Senior Securities
60
Item 4.
Submission of Matters to a Vote of Security Holders
60
Item 5.
Other Information
60
Item 6.
Exhibits
61
 
Signatures
62


 

 




 
-4-

 



Implant Sciences Corporation
 
Condensed Consolidated Balance Sheets
 
             
   
March 31,
   
June 30,
 
   
2010
   
2009
 
   
(Unaudited)
   
(Audited)
 
   
(Restated)
       
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 10,000     $ -  
Restricted cash and investments
    464,000       225,000  
Accounts receivable-trade, net of allowance of $97,000 and $65,000,  respectively
    162,000       201,000  
Accounts receivable, unbilled
    29,000       138,000  
Note receivable
    174,000       167,000  
Inventories
    327,000       561,000  
Prepaid expenses and other current assets
    991,000       518,000  
Assets of discontinued operations
    103,000       169,000  
Total current assets
    2,260,000       1,979,000  
Property and equipment, net
    186,000       276,000  
Note receivable
    623,000       766,000  
Restricted investments
    -       439,000  
Other non-current assets
    18,000       68,000  
Goodwill
    3,136,000       3,136,000  
Total assets
  $ 6,223,000     $ 6,664,000  
                 
LIABILITIES AND STOCKHOLDERS' DEFICIT
               
Current liabilities:
               
Cash overdraft
  $ -       6,000  
Senior secured convertible note, net
    4,120,000       4,049,000  
Senior secured note
    1,000,000       -  
Line of credit
    4,379,000       -  
Current maturities of long-term debt and obligations under capital lease
    21,000       27,000  
Note payable - related party
    100,000       100,000  
Payable to Med-Tec
    55,000       56,000  
Accrued expenses
    2,097,000       1,968,000  
Accounts payable
    2,867,000       4,337,000  
Current portion of long-term lease liability
    -       334,000  
Deferred revenue
    201,000       428,000  
Note conversion option liability
    12,791,000       -  
Liabilities of discontinued operations
    48,000       107,000  
Total current liabilities
    27,679,000       11,412,000  
Long-term liabilities:
               
Long-term debt and obligations under capital lease, net of current maturities
    67,000       86,000  
Long-term lease liability
    -       84,000  
Warrant derivative liability
    308,000       -  
Total long-term liabilities
    375,000       170,000  
Total liabilities
    28,054,000       11,582,000  
                 
Commitments and contingencies
               
                 
Series E Convertible Preferred Stock, $5 stated value; 1,000,000 shares
authorized, 1,000,000 shares outstanding (liquidation value $5,000,000)
    5,000,000       5,000,000  
                 
Stockholders' deficit:
               
Common stock; $0.10 par value; 50,000,000 shares authorized; 22,134,740 and
22,124,195 at March 31, 2010 and 15,434,740 and 15,424,195 at June 30, 2009
shares issued and outstanding, respectively
    2,213,000       1,543,000  
Preferred Stock; $0.10 par value: 5,000,000 shares authorized
               
Series F Convertible Preferred Stock, no stated value; 2,000,000 shares
authorized, 1,646,663 shares outstanding (liquidation value $274,000)
    274,000       -  
Additional paid-in capital
    61,527,000       61,290,000  
Accumulated deficit
    (90,755,000 )     (72,678,000 )
Deferred compensation
    (17,000 )     -  
Treasury stock, 10,545 common shares, respectively, at cost
    (73,000 )     (73,000 )
Total stockholders' deficit
    (26,831,000 )     (9,918,000 )
Total liabilities and stockholders' deficit
  $ 6,223,000     $ 6,664,000  
 
The accompanying notes are an integral part of these financial statements.
 



 
-5-

 

 
Implant Sciences Corporation
 
Condensed Consolidated Statements of Operations
 
(Unaudited)
 
                         
                         
   
For the Three Months Ended
   
For the Nine Months Ended
 
   
March 31,
   
March 31,
 
   
2010
   
2009
   
2010
   
2009
 
   
(Restated)
         
(Restated)
       
Revenues:
                       
Security products
  $ 636,000     $ 305,000     $ 2,767,000     $ 6,814,000  
Government contracts and services
    92,000       248,000       384,000       1,206,000  
      728,000       553,000       3,151,000       8,020,000  
Cost of revenues
    460,000       333,000       1,916,000       4,386,000  
Gross margin
    268,000       220,000       1,235,000       3,634,000  
Operating expenses:
                               
Research and development
    554,000       809,000       1,725,000       2,580,000  
Selling, general and administrative
    1,016,000       1,898,000       3,085,000       5,825,000  
Litigation settlements
    -       5,700,000       (384,000 )     5,700,000  
      1,570,000       8,407,000       4,426,000       14,105,000  
Loss from operations
    (1,302,000 )     (8,187,000 )     (3,191,000 )     (10,471,000 )
Other income (expense), net:
                               
Interest income
    14,000       15,000       46,000       35,000  
Interest expense
    (362,000 )     (377,000 )     (1,926,000 )     (1,182,000 )
Change in fair value of warrant derivative liability
    48,000       -       (247,000 )     -  
Change in fair value of note conversion option liability
    5,132,000       -       (11,608,000 )     -  
Gain on transfer of investment
    -       -       -       468,000  
Realized losses in unconsolidated subsidiary
    -       -       -       (123,000 )
Total other income (expense), net
    4,832,000       (362,000 )     (13,735,000 )     (802,000 )
Income (loss) from continuing operations
    3,530,000       (8,549,000 )     (16,926,000 )     (11,273,000 )
Preferred distribution, deemed dividends and accretion
                    (329,000 )     (207,000 )
Income (loss) from continuing operations
applicable to common shareholders
    3,530,000       (8,549,000 )     (17,255,000 )     (11,480,000 )
(Loss) income from discontinued operations, before
sale of discontinued operations
    -       (43,000 )     (20,000 )     954,000  
Gain on sale of Core Systems
    -       -       -       22,000  
Net (loss) income from discontinued operations
    -       (43,000 )     (20,000 )     976,000  
Net income (loss) applicable to common shareholders
  $ 3,530,000     $ (8,592,000 )   $ (17,275,000 )   $ (10,504,000 )
Net income (loss)
  $ 3,530,000     $ (8,592,000 )   $ (16,946,000 )   $ (10,297,000 )
                                 
Basic income (loss) per share:
                               
Income (loss) per share from continuing operations
  $ 0.16     $ (0.60 )   $ (0.95 )   $ (0.81 )
Income (loss) per share from continuing operations
applicable to common shareholders
  $ 0.16     $ (0.60 )   $ (0.97 )   $ (0.82 )
Income (loss) per share from discontinued operations
  $ 0.00     $ (0.00 )   $ (0.00 )   $ 0.07  
Net income (loss) per share applicable to common shareholders
  $ 0.16     $ (0.61 )   $ (0.97 )   $ (0.75 )
Net income (loss) per share
  $ 0.16     $ (0.61 )   $ (0.95 )   $ (0.74 )
                                 
Diluted income (loss) per share:
                               
Income (loss) per share from continuing operations
  $ 0.04     $ (0.60 )   $ (0.95 )   $ (0.81 )
Income (loss) per share from continuing operations
applicable to common shareholders
  $ 0.04     $ (0.60 )   $ (0.97 )   $ (0.82 )
Income (loss) per share from discontinued operations
  $ 0.00     $ (0.00 )   $ (0.00 )   $ 0.07  
Net income (loss) per share applicable to common shareholders
  $ 0.04     $ (0.61 )   $ (0.97 )   $ (0.75 )
Net income (loss) per share
  $ 0.04     $ (0.61 )   $ (0.95 )   $ (0.74 )
                                 
Weighted average shares used in computing net income (loss)
per common share:
                               
Basic
    21,874,195       14,154,990       17,818,640       13,919,545  
Diluted
    93,610,722       14,154,990       17,818,640       13,919,545  




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

 

 
-6-

 



Implant Sciences Corporation
 
Condensed Consolidated Statements of Cash Flows
 
(Unaudited)
 
             
   
For The Nine Months Ended March 31,
 
   
2010
   
2009
 
   
(Restated)
       
Cash flows from operating activities:
           
Net loss
  $ (16,946,000 )   $ (10,297,000 )
Less:  Net (loss) income from discontinued operations
    (20,000 )     976,000  
Loss from continuing operations
    (16,926,000 )     (11,273,000 )
Adjustments to reconcile net loss from continuing operations to net cash flows:
               
Depreciation and amortization
    95,000       207,000  
Bad debt expense (recoveries)
    32,000       55,000  
Share-based compensation expense
    115,000       278,000  
Fair value of common stock issued to consultants
    107,000       -  
Loss on disposal of fixed assets
    -       10,000  
Debt discount amortization
    1,107,000       953,000  
Fair value of warrants issued to non-employees
    14,000       (17,000 )
Warrant accretion on debt
    -       7,000  
Change in fair value of warrant derivative liability
    247,000       -  
Change in fair value of note conversion option liability
    11,608,000       -  
Realized losses in unconsolidated subsidiaries
    -       123,000  
Gain on transfer of investment
    -       (468,000 )
Litigation settlements
    (384,000 )     5,700,000  
Interest income on note receivable
    -       (6,000 )
Changes in assets and liabilities, net of effect of divestitures:
               
Accounts receivable
    116,000       532,000  
Inventories
    219,000       246,000  
Prepaid expenses and other current assets
    (467,000 )     (340,000 )
Cash overdraft
    (6,000 )     -  
Accounts payable
    (1,469,000 )     1,173,000  
Accrued expenses
    129,000       (127,000 )
Deferred revenue
    (227,000 )     (49,000 )
Lease liability
    -       (319,000 )
Net cash used in operating activities of continuing operations
    (5,690,000 )     (3,315,000 )
Net cash provided by operating activities of discontinued operations
    2,000       59,000  
Net cash used in operating activities
    (5,688,000 )     (3,256,000 )
Cash flows from investing activities:
               
Purchases of property and equipment
    (5,000 )     (16,000 )
Transfer from restricted funds, net
    200,000       25,000  
Proceeds from sale of property and equipment, net of transaction costs
    -       1,459,000  
Proceeds from the sale of Core Systems, net of transaction costs
    -       1,080,000  
Payments received on note receivable
    136,000       654,000  
Increase in other non-current assets
    -       18,000  
Net cash provided by investing activities of continuing operations
    331,000       3,220,000  
Net cash used in investing activities of discontinued operations
    -       (28,000 )
Net cash provided by investing activities
    331,000       3,192,000  
Cash flows from financing activities:
               
Proceeds from common stock issued in connection with exercise
of stock options and employee stock purchase plan
    -       24,000  
Proceeds from the issuance of senior secured promissory note
    1,000,000       4,734,000  
Principal payment on senior secured convertible promissory note
    -       (1,000,000 )
Dividends on Series D cumulative convertible preferred stock
    -       (52,000 )
Payments on Series D cumulative convertible preferred stock
    -       (2,724,000 )
Principal repayments of long-term debt and capital lease obligations
    (12,000 )     (336,000 )
Net borrowings (repayments) on line of credit
    4,379,000       (764,000 )
Net cash provided by (used in) financing activities of continuing operations
    5,367,000       (118,000 )
Net cash used in discontinued operations
    -       (1,000 )
Net cash provided by (used in) financing activities
    5,367,000       (119,000 )
Net change in cash and cash equivalents
    10,000       (183,000 )
Cash and cash equivalents at beginning of period
    -       412,000  
Cash and cash equivalents at end of period
  $ 10,000     $ 229,000  



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

 
-7-

 


 

 


Implant Sciences Corporation
 
Condensed Consolidated Statements of Cash Flows
 
(Unaudited)
 
             
   
For The Nine Months Ended March 31,
 
   
2010
   
2009
 
   
(Restated)
       
             
Supplemental Disclosure of Cash Flow Information:
           
Interest paid
  $ 318,000     $ 198,000  
                 
                 
Non-cash Investing and Financing Activity:
               
Accretion of Series D cumulative convertible preferred stock dividends,
derivatives and warrants
  $ -     $ 155,000  
Series F convertible preferred stock beneficial conversion feature
  $ 329,000     $ -  
Original issue discount on senior secured convertible promissory note
  $ -     $ 616,000  
Conversion of bank term note to line of credit
  $ -     $ 287,000  
Conversions of senior secured convertible promissory note to common shares
  $ 120,000     $ -  
Warrant issued to DMRJ Group, LLC
  $ -     $ 160,000  
Common stock issued Ion Metrics, Inc. acquisition
  $ -     $ 2,464,000  
Common stock issued in redemption of Series D cumulative
               
convertible preferred stock
  $ -     $ 268,000  
Common stock issued to consultants
  $ 107,000     $ -  
Fair value of Series F convertible preferred stock
  $ 274,000     $ -  



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

 

 
-8-

 
IMPLANT SCIENCES CORPORATION
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.  
Description of Business
 
Implant Sciences Corporation provides systems and sensors for the homeland security market and related industries.  We have developed and acquired technologies using ion mobility spectrometry to develop a product line for use in trace explosives detection.  We currently market and sell our existing trace explosives detector products while continuing to make significant investments in developing the next generation of these products.
 
Acquisition of Ion Metrics
 
In April 2008, we acquired all of the capital stock of Ion Metrics, Inc.  Ion Metrics was in the business of producing low-cost mass sensor systems for the detection and analysis of chemical compounds such as explosives, chemical warfare agents, narcotics, and toxic industrial chemicals for the homeland defense, forensic, environmental, and safety/security markets. The transaction was structured as a reorganization of Ion Metrics with and into our newly formed, wholly-owned subsidiary. The total purchase price, including $564,000 of assumed liabilities, was approximately $3,309,000.  As part of the transaction, we issued to the former stockholders of Ion Metrics consideration consisting of 2,000,000 shares of our common stock, par value $0.10 per share. The integration of the Ion Metrics technologies into our Quantum SnifferTM product line is expected to provide opportunities to introduce smaller, lower-cost, and higher performance security solutions.
 
Sale of Accurel
 
In May 2007, we sold substantially all of the assets of our Accurel Systems subsidiary to Evans Analytical Group, LLC for approximately $12,705,000, including $1,000,000 held by an escrow agent as security for certain representations and warranties.  In February 2008, Evans filed suit in the Superior Court of the State of California, Santa Clara County, requesting rescission of the asset purchase agreement, plus damages, based on claims of misrepresentation and fraud.  In March 2008, Evans filed a notice with the escrow agent prohibiting release of any portion of the escrow to us pending resolution of the lawsuit.  In March 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 (i) agreeing to release to Evans approximately $700,000 that had been held in escrow since the time of the closing of the Accurel sale and (ii) agreeing to issue to Evans 1,000,000 shares of Series E Convertible Preferred Stock having an aggregate liquidation preference of $5,000,000.  In April 2009, $700,000 of the funds held in escrow, together with accrued interest, was released to Evans and $300,000, the balance of the escrow amount, was released to us.
 
Sale of Core
 
In November 2008, we entered into a definitive agreement, with Core Systems Incorporated, an entity newly formed by the Subsidiary’s general manager and certain other investors (the “Buyer”), to sell substantially all the assets of our wholly owned semiconductor subsidiary, C Acquisition Corp., which had operated under the name Core Systems (the “Subsidiary”), for a purchase price of $3,000,000 plus the assumption of certain liabilities.  The Buyer made a cash down payment of $250,000 prior to the execution of the definitive agreement.  On November 24, 2008, the parties amended the agreement and completed the asset sale.  On that date, the Buyer made a cash payment of $1,125,000 and issued a promissory note in the amount of $1,625,000.  The promissory note required the Buyer to pay the Subsidiary $125,000 on or before November 28, 2008, an additional $500,000 on or before December 24, 2008, and the remaining principal balance, together with accrued interest, in equal monthly installments over a period of 60 months commencing on February 1, 2009.  The Buyer and the Subsidiary also executed a security agreement, pursuant to which the Buyer granted the Subsidiary a security interest in all of the Buyer’s assets to secure our obligations under the promissory note.  The Buyer paid $250,000 of the amount due in December and paid the remaining $250,000 balance due in March 2009.
 

 
-9-

 
IMPLANT SCIENCES CORPORATION
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Sale of Medical Reporting Unit
 
In June 2007, we sold certain of the assets related to our brachytherapy products and divested the prostate seed and medical software businesses.  In March 2008, we informed our medical coatings customers of our intention to discontinue coating operations by the end of the 2008 calendar year.  During the nine months ended March 31, 2009, under three separate asset purchase agreements, we sold certain assets of our medical coatings business, with gross proceeds aggregating approximately $1,592,000. The Medical Reporting Unit is reported as discontinued operations in the accompanying financial statements.
 
CorNova
 
We had partnered with CorNova, Inc., a privately-held, development stage company focused on the development of a next-generation drug-eluting stent, and were issued 1,500,000 shares of CorNova’s common stock representing a 15% ownership interest.  On December 10, 2008, we transferred the CorNova shares in connection with the issuance of the senior secured convertible promissory note (See Note 14).
 
Liquidity, Going Concern and Management’s Plans
 
Despite our current sales, expense and cash flow projections and the cash available from our line of credit with DMRJ Group LLC, we require additional capital in the first quarter of fiscal 2011 to repay our senior secured convertible promissory note, secured promissory note and line of credit, each of which mature on September 30, 2010, 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.
 
In addition, while we strive to bring new products to market, we are subject to a number of risks similar to the risks faced by other technology-based companies, including risks related to: (a) our dependence on key individuals and collaborative research partners; (b) competition from substitute products and larger companies; (c) our ability to develop and market commercially usable products and obtain regulatory approval for our products under development; and (d) our ability to obtain substantial additional financing necessary to adequately fund the development, commercialization and marketing of our products.  For the nine months ended March 31, 2010, we reported a net loss applicable to common shareholders of $17,275,000, a loss from continuing operations of $16,926,000 and used $5,688,000 in cash from operations.  As of March 31, 2010, we had an accumulated deficit of approximately $90,755,000 and a working capital deficit of $25,419,000.  Management continually evaluates plans to reduce our operating expenses and increase our cash flow from operations.  Failure to achieve our projections may require us to seek additional financing or discontinue operations.
 
Based on current sales, operating expense and cash flow projections, and the cash available from our line of credit, management believes there are plans in place to sustain operations for the next several months.  These plans depend on a substantial increase in sales of our handheld trace explosives detector product.  To further sustain us, improve our cash position, and enable us to grow while reducing debt, management plans to continue to seek additional capital through private financing sources during the next three months.  However, there can be no assurance that management will be successful in executing these plans.  Management will continue to closely monitor and attempt to control our costs and actively seek needed capital through sales of our products, equity infusions, government grants and awards, strategic alliances, and through our lending institutions.
 
We have suffered recurring losses from operations.  Our consolidated financial statements have been presented on the basis that it is a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.
 

 
-10-

 
IMPLANT SCIENCES CORPORATION
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

There can be no assurances that our forecasted results will be achieved or that we will be able to raise additional capital necessary to operate our business.  These conditions raise substantial doubt about our ability to continue as a going concern.  The financial statements do not include any adjustments relating to the recoverability and classification of asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.
 
We have experienced a reduction in security revenue in the nine-month period ended March 31, 2010 as compared with the comparable prior year period, relating to a decline in unit sales of our trace explosives products. Security product sales tend to have a long sale cycle, and are often subject to export controls.  In an effort to identify new opportunities and stimulate sales, we have implemented a new sales tool to assist in this effort.  However, there can be no assurance that these efforts will increase revenue.
 
We have a history of being active in submitting proposals for government sponsored grants and contracts and successful in being awarded grants and contracts from government agencies. However, we have experienced a decline in government contract revenue in the nine-month period ended March 31, 2010 as compared to the comparable prior year period, due to the expiration of several contracts.  Management will continue to pursue these grants and contracts to support our research and development efforts primarily in the areas of trace explosives detection.
 
In June, August, October and November 2008, we entered into a series of amendments, waivers and modifications to our credit agreements with Bridge Bank, N.A., pursuant to which, in exchange for the payment by us of forbearance fees in the amount of $90,000, the bank waived certain existing and anticipated defaults, the bank reduced our credit line to $1,500,000 from $5,000,000, and extended the modified facility through December 10, 2008. On December 10, 2008, we used approximately $477,000 of the proceeds of the sale of the senior secured convertible promissory note (see Note 14) to repay all of the indebtedness outstanding to the bank and the credit facility was terminated.  As of March 31, 2010 and 2009, our obligation for borrowed funds under the credit facility amounted to $0.
 
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.  We have entered into a series of amendments, waivers and modifications with DMRJ. 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 (i) an amended and restated senior secured convertible promissory note dated March 12, 2009, (ii) a senior secured convertible promissory note dated July 1, 2009 and (iii) a revolving promissory note dated September 4, 2009, was extended from June 10, 2010 to September 30, 2010 (see Notes 14, 15, 16 and 19).
 
The failure to refinance or otherwise negotiate further 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.
 

 
-11-

 
IMPLANT SCIENCES CORPORATION
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
We are currently expending significant resources to develop the next generation of our current products and to develop new products.  Although we continue to fund as much research and development as possible through government grants and contracts in accordance with the provisions of the respective grant awards, we will require additional funding in order to continue the advancement of the commercial development and manufacturing of the explosives detection system.  We will attempt to obtain such financing by: (i) government grants, (ii) private financing, or (iii) strategic partnerships.  However, there can be no assurance that we will be successful in our attempts to raise such additional financing.
 
We require substantial funds for further research and development, regulatory approvals, and the marketing of our explosives detection products.  Our capital requirements depend on numerous factors, including but not limited to the progress of our research and development programs; the cost of filing, prosecuting, defending and enforcing any intellectual property rights; competing technological and market developments; changes in our development of commercialization activities and arrangements; the hiring of additional personnel, and acquiring capital equipment.
 
Under our agreements with Laurus Master Fund, Ltd. we were required to redeem our Series D Cumulative Redeemable Convertible Preferred Stock on a monthly basis, with the final redemption payment to be made in September 2008.  We received a waiver of the monthly redemption payments for the period December 2006 through August 2007 and, in September 2007, we resumed making monthly redemptions.  In September, 2008, Laurus agreed to extend the final redemption date to October 24, 2008 in exchange for a redemption payment of $250,000, including $22,000 of accrued dividends.  We did not meet our redemption obligation on October 24, 2008 and, on November 4, 2008, we amended our agreements with Laurus, effective as of October 31, 2008, to provide that the amount necessary to redeem in full the Series D Preferred Stock would be increased to $2,461,000, together with accrued and unpaid dividends.  Under these amendments, we agreed to make monthly redemption payments through a new final redemption date of April 10, 2009.  We redeemed $268,000 of the $518,000 of Series D Preferred Stock required to be redeemed as of the October 31, 2008 redemption date by agreeing to issue 929,535 shares of our common stock, and redeemed the balance with a cash payment of $250,000.  On December 10, 2008, we used approximately $1,161,000 of the proceeds of the sale of the senior secured convertible promissory note (see Note 13) to redeem in full all of our outstanding Series D Preferred Stock.  In May 2009, we issued 929,535 shares of our common stock to an affiliate of Laurus completing the redemption of the Preferred Series D.  As of March 31, 2010 and 2009, our obligation to redeem the Series D Preferred Stock amounted to $0.
 
2.  
Interim Financial Statements and Basis of Presentation
 
The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”).  In the opinion of management, the accompanying condensed consolidated financial statements include all adjustments (consisting only of normal recurring adjustments), which we consider necessary for a fair presentation of the financial position at such date and of the operating results and cash flows for the periods presented.  All intercompany balances and transactions have been eliminated in consolidation. The results of operations for the three and nine months ended March 31, 2010 and cash flows for the nine months ended March 31, 2010 may not necessarily be indicative of results that may be expected for any succeeding quarter or for the entire fiscal year.  The information contained in this Form 10-Q/A should be read in conjunction with our audited financial statements, included in our Form 10-K, as amended, as of and for the year ended June 30, 2009.
 
The balance sheet at June 30, 2009 has been derived from our audited consolidated financial statements at that date, but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.
 

 
-12-

 
IMPLANT SCIENCES CORPORATION
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
The accompanying condensed consolidated financial statements include our operations in Massachusetts and California.
 
As a result of our decision to dispose of Core, the operating results of Core are presented in the accompanying condensed consolidated statements of operations as discontinued operations for the nine months ended March 31, 2009.
 
As a result of our decision to dispose of the medical business unit, the assets and liabilities of the medical business unit are presented in the accompanying condensed consolidated balance sheets as assets and liabilities held for sale as of March 31, 2010 and June 30, 2009, and the operating results of the medical business unit are presented in the accompanying condensed consolidated statements of operations as discontinued operations for the three and nine months ended March 31, 2010 and 2009.
 
Additionally, the following notes to the condensed consolidated financial statements include disclosures related to our continuing operations unless specifically identified as disclosures related to discontinued operations.
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and judgments, which are evaluated on an ongoing basis, that affect the amounts reported in our condensed consolidated financial statements and accompanying notes.  Management bases our estimates on historical experience and on various other assumptions that it believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the amounts of revenues and expenses that are not readily apparent from other sources.  Actual results could differ from those estimates and judgments.  In particular, significant estimates and judgments include those related to revenue recognition, allowance for doubtful accounts, useful lives of property and equipment, inventory reserves, valuation for goodwill and acquired intangible assets, and realization of amounts held in escrow.
 
We have evaluated subsequent events after the balance sheet date through the date of filing of these financial statements with the SEC on May 19, 2010, for appropriate accounting and disclosure.
 
Significant accounting policies are described in Note 2 to the financial statements included in Item 7 of our Form 10-K, as amended, as of June 30, 2009.  The following updates our critical accounting policies through the fiscal quarter ended March 31, 2010.
 
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 815-40-15, 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 (See discussion of accounting changes in Note 3) 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 we issue additional shares of common stock (or securities convertible into or exercisable for additional shares of common stock) at a price below the exercise price, 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 three and nine months ended March 31, 2010, we recorded  non-cash benefit (charge) of $48,000 and ($247,000), respectively. 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 / income recognized for changes in the valuation of the warrants liability.
 

 
-13-

 
IMPLANT SCIENCES CORPORATION
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
Note Conversion Option Liability.
 
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 (See discussion of accounting changes in Note 3) 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 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. For the three and nine months ended March 31, 2010, we recorded non-cash benefit (charge) of $5,132,000 and ($11,608,000), respectively. 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/ income recognized for changes in the valuation of the note conversion liability.
 
Series F Convertible Preferred Stock – Beneficial Conversion Feature
 
On July 1, 2009, in connection with the issuance of the $1,000,000 senior secured promissory note, 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 issued such additional shares to DMRJ.  In accordance with Accounting Standards Codification (“ASC”) 470-20 “Debt”, a conversion feature is beneficial, or “in the money,” when the conversion rate of the convertible security is below the market price of the underlying common stock. The beneficial conversion feature is treated as a deemed dividend to the preferred shareholders. On July 1, 2009 and August 31, 2009, the commitment dates for the Series F Preferred stock issuances, the fair value of our common stock was $0.10. The initial conversion price of the Series F Preferred Stock was $0.08 per share.  As of July 1, 2009 and August 31, 2009, the beneficial conversion feature on the Series F Preferred Stock aggregated to $329,000 and is accounted for as a deemed dividend.
 
We considered several factors in determining the value of our common stock for use in the binomial option model calculation.  Due to our financial condition, our common stock is not traded on a national exchange, but is traded on 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.  We have issued a warrant, a convertible debt instrument and a convertible preferred stock instrument which are convertible into a significant number of common shares to DMRJ, our primary investor.  In addition, we have considered the historical daily trading volume of our stock and the potential impact that a significant issuance of shares of our common stock would have on our stock price.  Due to these factors, we applied a 20% discount to the price of our stock on the date of the calculation of the warrant derivative liability and note conversion option liability fair values.
 
3.  
Restatement
 
Background
 
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 815-40-15 “Derivatives and Hedging” related to the non-cash accounting treatment of financial instruments which are not deemed to be indexed to our common stock. ASC 815 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.  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 a result, we will restate 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.
 

 
-14-

 
IMPLANT SCIENCES CORPORATION
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On December 10, 2008, we entered into a note and warrant purchase agreement with DMRJ Group LLC, 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 promissory note and warrant were each amended and restated as of March 12, 2009. Both the promissory note and the warrant contain 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 conversion price of the promissory note and 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.  We determined that the conversion option and 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 and will record a cumulative-effect adjustment to the opening balance of accumulated deficit at July 1, 2009.
 
On July 1, 2009, in connection with the issuance of the $1,000,000 senior secured promissory note, 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 issued such additional shares to DMRJ.  In accordance with Accounting Standards Codification (“ASC”) 470-20 “Debt”, a conversion feature is beneficial, or “in the money,” when the conversion rate of the convertible security is below the market price of the underlying common stock. The beneficial conversion feature is treated as a deemed dividend to the preferred shareholders.
 
Cumulative Effect of a Change in Accounting Principle
 
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 )



 

 
-15-

 
IMPLANT SCIENCES CORPORATION
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
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 815-40-15, 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 warrant to purchase 1,000,000 shares of our common stock. 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 exercise price, 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 three and nine months ended March 31, 2010, we recorded non-cash benefit (charge) of $48,000 and ($247,000), respectively, 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 / income recognized for changes in the valuation of the warrants liability.
 
Note Conversion Option Liability
 
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 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. For the three and nine months ended March 31, 2010, we recorded non-cash benefit (charge) of $5,132,000 and ($11,608,000), respectively, 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/ income recognized for changes in the valuation of the note conversion liability.
 
Series F Convertible Preferred Stock – Beneficial Conversion Feature
 
On July 1, 2009, in connection with the issuance of the $1,000,000 senior secured promissory note, 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 issued such additional shares to DMRJ.  In accordance with Accounting Standards Codification (“ASC”) 470-20 “Debt”, a conversion feature is beneficial, or “in the money,” when the conversion rate of the convertible security is below the market price of the underlying common stock. The beneficial conversion feature is treated as a deemed dividend to the preferred shareholders. On July 1, 2009 and August 31, 2009, the commitment dates for the Series F Preferred stock issuances, the fair value of our common stock was $0.10. The initial conversion price of the Series F Preferred Stock was $0.08 per share.  As of July 1, 2009 and August 31, 2009, the beneficial conversion feature on the Series F Preferred Stock aggregated to $329,000 and is accounted for as a deemed dividend.
 
Impact of the Restatement
 
The cumulative effect of these adjustments to our financial statements is a $12,764,000, or 16.4%, increase in accumulated deficit as of March 31, 2010.
 

 
-16-

 
IMPLANT SCIENCES CORPORATION
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The effect of the adjustments on our consolidated financial statements for the quarter ended March 31, 2010 are summarized as follows:
 
Condensed Consolidated Balance Sheets

Implant Sciences Corporation
 
Condensed Consolidated Balance Sheets
 
(Unaudited)
 
                   
   
March 31, 2010
 
   
As Originally
             
   
Reported
   
Adjustments
   
As Restated
 
ASSETS
                 
Current assets:
                 
Cash and cash equivalents
  $ 10,000     $ -     $ 10,000  
Restricted cash and investments
    464,000               464,000  
Accounts receivable-trade, net of allowance of $97,000
    162,000               162,000  
Accounts receivable, unbilled
    29,000               29,000  
Note receivable
    174,000               174,000  
Inventories
    327,000               327,000  
Prepaid expenses and other current assets
    991,000               991,000  
Assets of discontinued operations
    103,000               103,000  
Total current assets
    2,260,000       -       2,260,000  
Property and equipment, net
    186,000               186,000  
Note receivable
    623,000               623,000  
Other non-current assets
    18,000               18,000  
Goodwill
    3,136,000               3,136,000  
Total assets
  $ 6,223,000     $ -     $ 6,223,000  
                         
LIABILITIES AND STOCKHOLDERS' DEFICIT
                       
Current liabilities:
                       
Senior secured convertible note, net
  $ 4,120,000     $ -     $ 4,120,000  
Senior secured note
    1,000,000               1,000,000  
Line of credit
    4,379,000               4,379,000  
Current maturities of long-term debt and obligations under capital lease
    21,000               21,000  
Note payable - related party
    100,000               100,000  
Payable to Med-Tec
    55,000               55,000  
Accrued expenses
    2,097,000               2,097,000  
Accounts payable
    2,867,000               2,867,000  
Deferred revenue
    201,000               201,000  
Note conversion option liability
    -       12,791,000       12,791,000  
Liabilities of discontinued operations
    48,000               48,000  
Total current liabilities
    14,888,000       12,791,000       27,679,000  
Long-term liabilities:
                       
Long-term debt and obligations under capital lease, net of current maturities
    67,000               67,000  
Warrant derivative liability
    390,000       (82,000 )     308,000  
Total long-term liabilities
    457,000       (82,000 )     375,000  
Total liabilities
    15,345,000       12,709,000       28,054,000  
                         
Commitments and contingencies
                       
                         
Series E Convertible Preferred Stock, $5 stated value; 1,000,000 shares
authorized, 1,000,000 shares outstanding (liquidation value $5,000,000)
    5,000,000               5,000,000  
                         
Stockholders' deficit:
                       
Common stock; $0.10 par value; 50,000,000 shares authorized; 22,134,740 and
22,124,195 shares issued and authorized, respectively,  at March 31, 2010
    2,213,000               2,213,000  
Preferred Stock; $0.10 par value: 5,000,000 shares authorized
                       
Series F Convertible Preferred Stock, no stated value; 2,000,000 shares
authorized, 1,646,663 shares outstanding (liquidation value $274,000)
    378,000       (104,000 )     274,000  
Additional paid-in capital
    61,368,000       159,000       61,527,000  
Accumulated deficit
    (77,991,000 )     (12,764,000 )     (90,755,000 )
Deferred compensation
    (17,000 )             (17,000 )
Treasury stock, 10,545 common shares, at cost
    (73,000 )             (73,000 )
Total stockholders' deficit
    (14,122,000 )     (12,709,000 )     (26,831,000 )
Total liabilities and stockholders' deficit
  $ 6,223,000     $ -     $ 6,223,000  



 
-17-

 
IMPLANT SCIENCES CORPORATION
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Condensed Consolidated Statements of Operations
 
Implant Sciences Corporation
 
Condensed Consolidated Statements of Operations
 
(Unaudited)
 
                                     
                                     
   
For the Three Months Ended March 31, 2010
   
For the Nine Months Ended March 31, 2010
 
   
As Originally
               
As Originally
             
   
Reported
   
Adjustments
   
As Restated
   
Reported
   
Adjustments
   
As Restated
 
Revenues:
                                   
Security products
  $ 636,000     $ -     $ 636,000     $ 2,767,000     $ -     $ 2,767,000  
Government contracts and services
    92,000               92,000       384,000               384,000  
      728,000       -       728,000       3,151,000       -       3,151,000  
Cost of revenues
    460,000               460,000       1,916,000               1,916,000  
Gross margin
    268,000       -       268,000       1,235,000       -       1,235,000  
Operating expenses:
                                               
Research and development
    554,000               554,000       1,725,000               1,725,000  
Selling, general and administrative
    1,016,000               1,016,000       3,085,000               3,085,000  
Litigation settlement
    -               -       (384,000 )             (384,000 )
      1,570,000       -       1,570,000       4,426,000       -       4,426,000  
Loss from operations
    (1,302,000 )     -       (1,302,000 )     (3,191,000 )     -       (3,191,000 )
Other income (expense), net:
                                               
Interest income
    14,000               14,000       46,000               46,000  
Interest expense
    (362,000 )     -       (362,000 )     (1,758,000 )     (168,000 )     (1,926,000 )
Change in fair value of warrant derivative liability
    (390,000 )     438,000       48,000       (390,000 )     143,000       (247,000 )
Change in fair value of note conversion option liability
    -       5,132,000       5,132,000       -       (11,608,000 )     (11,608,000 )
Total other income (expense), net
    (738,000 )     5,570,000       4,832,000       (2,102,000 )     (11,633,000 )     (13,735,000 )
Income (loss) from continuing operations
    (2,040,000 )     5,570,000       3,530,000       (5,293,000 )     (11,633,000 )     (16,926,000 )
Preferred distribution, deemed dividends and accretion
    -       -       -       -       (329,000 )     (329,000 )
Income (loss) from continuing operations
applicable to common shareholders
    (2,040,000 )     5,570,000       3,530,000       (5,293,000 )     (11,962,000 )     (17,255,000 )
(Loss) income from discontinued operations
    -               -       (20,000 )             (20,000 )
Net income (loss) applicable to common shareholders
  $ (2,040,000 )   $ 5,570,000     $ 3,530,000     $ (5,313,000 )   $ (11,962,000 )   $ (17,275,000 )
Net income (loss)
  $ (2,040,000 )   $ 5,570,000     $ 3,530,000     $ (5,313,000 )   $ (11,633,000 )   $ (16,946,000 )
                                                 
Basic income (loss) per share:
                                               
Income (loss) per share from continuing operations
  $ (0.10 )   $ 0.25     $ 0.16     $ (0.30 )   $ (0.65 )   $ (0.95 )
Income (loss) per share from continuing operations
   applicable to common shareholders
  $ (0.10 )   $ 0.25     $ 0.16     $ (0.30 )   $ (0.67 )   $ (0.97 )
Income (loss) per share from discontinued operations
  $ 0.00     $ 0.00     $ 0.00     $ (0.00 )   $ 0.00     $ (0.00 )
Net income (loss) per share applicable
   to common shareholders
  $ (0.10 )   $ 0.25     $ 0.16     $ (0.30 )   $ (0.67 )   $ (0.97 )
Net income (loss) per share
  $ (0.10 )   $ 0.25     $ 0.16     $ (0.30 )   $ (0.65 )   $ (0.95 )
                                                 
Diluted income (loss) per share:
                                               
Income (loss) per share from continuing operations
  $ (0.10 )   $ 0.06     $ 0.04     $ (0.30 )   $ (0.65 )   $ (0.95 )
Income (loss) per share from continuing operations
   applicable to common shareholders
  $ (0.10 )   $ 0.06     $ 0.04     $ (0.30 )   $ (0.67 )   $ (0.97 )
Income (loss) per share from discontinued operations
  $ 0.00     $ 0.00     $ 0.00     $ (0.00 )   $ 0.00     $ (0.00 )
Net income (loss) per share applicable
   to common shareholders
  $ (0.10 )   $ 0.06     $ 0.04     $ (0.30 )   $ (0.67 )   $ (0.97 )
Net income (loss) per share
  $ (0.10 )   $ 0.06     $ 0.04     $ (0.30 )   $ (0.65 )   $ (0.95 )
                                                 
Weighted average shares and equivalents:
                                               
Basic
    19,674,195       21,874,195       21,874,195       17,818,640       17,818,640       17,818,640  
Diluted
    19,674,195       93,610,722       93,610,722       17,818,640       17,818,640       17,818,640  




 

 
-18-

 
IMPLANT SCIENCES CORPORATION
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Condensed Consolidated Statements of Cash Flows

Implant Sciences Corporation
 
Condensed Consolidated Statements of Cash Flows
 
(Unaudited)
 
                   
   
For The Nine Months Ended March 31, 2010
 
   
As Originally
             
   
Reported
   
Adjustments
   
As Restated
 
Cash flows from operating activities:
                 
Net loss
  $ (5,313,000 )   $ (11,633,000 )   $ (16,946,000 )
Less:  Net (loss) income from discontinued operations
    (20,000 )             (20,000 )
Loss from continuing operations
    (5,293,000 )     (11,633,000 )     (16,926,000 )
Adjustments to reconcile net loss from continuing operations to net cash flows:
                       
Depreciation and amortization
    95,000               95,000  
Bad debt expense (recoveries)
    32,000               32,000  
Share-based compensation expense
    115,000               115,000  
Fair value of common stock issued to consultants
    107,000               107,000  
Debt discount amortization
    868,000       239,000       1,107,000  
Fair value of warrants issued to non-employees
    14,000               14,000  
Warrant accretion on debt
    71,000       (71,000 )     -  
Change in fair value of warrant derivative liability
    390,000       (143,000 )     247,000  
Change in fair value of note conversion option liability
    -       11,608,000       11,608,000  
Litigation settlement
    (384,000 )             (384,000 )
Changes in assets and liabilities, net of effect of divestitures:
                       
Accounts receivable
    116,000               116,000  
Inventories
    219,000               219,000  
Prepaid expenses and other current assets
    (468,000 )     1,000       (467,000 )
Cash overdraft
    (6,000 )             (6,000 )
Accounts payable
    (1,468,000 )     (1,000 )     (1,469,000 )
Accrued expenses
    129,000               129,000  
Deferred revenue
    (227,000 )             (227,000 )
Net cash used in operating activities of continuing operations
    (5,690,000 )     -       (5,690,000 )
Net cash provided by operating activities of discontinued operations
    2,000               2,000  
Net cash used in operating activities
    (5,688,000 )     -       (5,688,000 )
Cash flows from investing activities:
                       
Purchases of property and equipment
    (5,000 )             (5,000 )
Transfer from restricted funds, net
    200,000               200,000  
Payments received on note receivable
    136,000               136,000  
Net cash provided by investing activities of continuing operations
    331,000       -       331,000  
Net cash used in investing activities of discontinued operations
    -               -  
Net cash provided by investing activities
    331,000       -       331,000  
Cash flows from financing activities:
                       
Proceeds from the issuance of senior secured promissory notes
    1,000,000               1,000,000  
Principal repayments of long-term debt and capital lease obligations
    (12,000 )             (12,000 )
Net borrowings on line of credit
    4,379,000               4,379,000  
Net cash provided by financing activities of continuing operations
    5,367,000       -