10-Q 1 imsc151231_10q.htm 151231 IMSC FORM 10-Q Form 10-Q - 2014 Q1  (M0590221.DOC;3)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)




QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


 

 

X

 

For the quarterly period ended December 31, 2015


 

 


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


Massachusetts


042837126

(State or other jurisdiction of incorporation or organization)


(I.R.S. Employer Identification No.)




500 Research Drive, Unit 3, Wilmington, Massachusetts


01887

(Address of principal executive offices)


(Zip Code)




(978) 752-1700

(Registrants 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  No

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes No

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):

 Large Accelerated Filer

Accelerated Filer

 Non-accelerated Filer

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  No

As of February 5, 2016, there were 78,805,620 shares of the registrants Common Stock outstanding. As of December 31, 2015, the last business day of the registrants most recent completed second quarter, the aggregate market value of the registrants 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 $39,582,000 based on the last sale price as reported by the Over-The-Counter-Bulletin-Board on such date.




 



IMPLANT SCIENCES CORPORATION

TABLE OF CONTENTS






Page

PART I


FINANCIAL INFORMATION



Item 1.


Condensed Consolidated Financial Statements





Condensed Consolidated Balance Sheets as of December 31, 2015 (unaudited) and     June 30, 2015 (audited)


3



Condensed Consolidated Statements of Operations and Comprehensive Loss for the three and six months ended December 31, 2015 and 2014 (unaudited)


4



Condensed Consolidated Statements of Cash Flows for the six months ended     December 31, 2015 and 2014 (unaudited)


5



Notes to Condensed Consolidated Financial Statements (unaudited)


624

Item 2.


Managements Discussion and Analysis of Financial Condition and Results of Operations


25-33

Item 4.


Controls and Procedures


33-34

PART II


OTHER INFORMATION



Item 1.


Legal Proceedings


34-35

Item 1A.


Risk Factors


35

Item 2.


Unregistered Sales of Equity Securities and Use of Proceeds


36

Item 6.


Exhibits


37




 



2





 

 

 

 

Implant Sciences Corporation

Condensed Consolidated Balance Sheets

(In thousands except share and per share amounts)


December 31,

2015


June 30,

2015


(Unaudited)


(Audited)

ASSETS




Current assets:




   Cash and cash equivalents

$

776 


$

1,985 

   Restricted cash and investments

367 


367 

   Accounts receivable-trade, net of allowances of $5 and $47,  respectively

6,116 


872 

   Inventories, net

6,723 


5,244 

   Prepaid expenses and other current assets

491 


946 

        Total current assets

14,473 


9,414 

Property and equipment, net

841 


880 

Other non-current assets

98 


98 

        Total assets

$

15,412 


$

10,392 

LIABILITIES AND STOCKHOLDERS' DEFICIT




Current liabilities:




   Senior secured promissory note BAM

$

20,000 


$

20,000 

   Senior secured convertible promissory note Montsant Partners

3,184 


3,184 

   Senior secured promissory note DMRJ

1,000 


1,000 

   Second senior secured convertible promissory note DMRJ

12,000 


12,000 

   Third senior secured convertible promissory note - DMRJ

12,000 


12,000 

   Line of credit DMRJ

16,862 


16,662 

   Current maturities of obligations under capital lease

26 


45 

   Accrued expenses

24,759 


17,080 

   Accounts payable

4,797 


2,855 

   Deferred revenue

1,466 


3,454 

      Total current liabilities

96,094 


88,280 

Long-term liabilities:




   Long-term obligations under capital lease, net of current maturities

15 


20 

   Accrued expenses, net of current


48 

   Deferred revenue, net of current

355 


221 

   Total long-term liabilities

370 


289 

      Total liabilities

96,464 


88,569 

Commitments and contingencies  (Note 16)




Stockholders' deficit:




   Common stock; $0.001 par value; 200,000,000 shares authorized; 78,699,165 and 78,688,620  shares issued and outstanding at December 31, 2015 and 75,113,665 and 75,103,120 shares issued and outstanding at June 30, 2015

79 


75 

   Preferred stock; no stated value; 5,000,000 shares authorized




      Series G Convertible Preferred Stock, no stated value; 650,000 shares authorized, no shares issued and outstanding


      Series H Convertible Preferred Stock; no stated value; 15,000 shares authorized, no shares issued and outstanding


      Series I Convertible Preferred Stock; no stated value; 15,000 shares authorized, no shares issued and outstanding


      Series J Convertible Preferred Stock; no stated value; 6,000 shares authorized, no shares issued and outstanding


   Additional paid-in capital

113,566 


112,613 

   Accumulated deficit

(193,653)


(189,429)

   Deferred compensation

(993)


(1,366)

   Other comprehensive income

22 


   Treasury stock, 10,545 common shares, at cost

(73)


(73)

      Total stockholders deficit

(81,052)


(78,177)

         Total liabilities and stockholders deficit

$

15,412 


$

10,392 

 

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




 



3





Implant Sciences Corporation

Condensed Consolidated Statements of Operations and Comprehensive Loss

(In thousands except share and per share amounts)

(Unaudited)










For the Three Months Ended

December 31,


For the Six Months Ended

December 31,


2015


2014


2015


2014

Revenues

$

10,292 


$

2,141 


$

24,685 


$

4,010 

Cost of revenues

6,439 


1,777 


14,575 


3,028 

   Gross margin

3,853 


364 


10,110 


982 

Operating expenses:








   Research and development

901 


1,288 


1,984 


2,572 

   Selling, general and administrative

3,718 


3,195 


7,256 


5,870 

      Total operating expenses

4,619 


4,483 


9,240 


8,442 

(Loss) income from operations

(766)


(4,119)


870 


(7,460)

Other income (expense), net:








   Interest expense

(2,547)


(2,125)


(5,094)


(4,159)

Net loss  

(3,313)


(6,244)


(4,224)


(11,619)









Other comprehensive loss net of tax:








   Foreign currency translation adjustments

(9)



(19)


Comprehensive loss

$

(3,322)


$

(6,240)


$

(4,243)


$

(11,618)









Net loss per share, basic and diluted

$

(0.04)


$

(0.09)


$

(0.05)


$

(0.17)









Weighted average shares used in computing net loss per common share, basic and diluted

78,528,620 


70,938,120 


77,367,787 


67,842,872 


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




 



4





 

 

 

 

Implant Sciences Corporation

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)






For the Six Months Ended

December 31,


2015


2014

Cash flows from operating activities:




   Net loss

$

(4,224)


$

(11,619)

   Adjustments to reconcile net loss to net cash flows used in operating activities:




      Depreciation and amortization

104 


81 

      Bad debt expense

(7)


46 

      Stock-based compensation expense

668 


1,227 

      Warrants issued to non-employees

43 


241 

      Common stock issued to consultants

331 


68 

      Changes in assets and liabilities:




         Accounts receivable

(5,237)


(416)

         Inventories

(1,479)


170 

         Prepaid expenses and other current assets

455 


37 

         Accounts payable

1,942 


(134)

         Accrued expenses

7,885 


3,125 

         Deferred revenue

(1,854)


1,279 

            Net cash used in operating activities

(1,373)


(5,895)





Cash flows from investing activities:




   Purchases of property and equipment

(65)


(314)

            Net cash used in investing activities

(65)


(314)





Cash flows from financing activities:




   Proceeds from common stock issued in connection with exercise of stock options and common stock purchase warrants

34 


261 

   Principal repayments of long-term debt and capital lease obligations

(24)


(23)

   Net borrowings on line of credit

200 


5,605 

            Net cash provided by financing activities

210 


5,843 

            Effect of exchange rate changes on cash and cash equivalents

19 


            Net change in cash and cash equivalents

(1,209)


(365)

            Cash and cash equivalents at beginning of period

1,985 


391 

            Cash and cash equivalents at end of period

$

776 


$

26 





Supplemental Disclosure of Cash Flow Information:




   Interest paid

$


$

1,619 

Non-cash Financing Activity:




   Conversions of senior secured convertible promissory note interest to common

       shares

$

245 


$

604 

   Common stock issued to consultants

331 


68 


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

 



5



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


1.    Description of Business, Liquidity and Going Concern

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 and narcotics detection.  We currently market and sell our existing trace explosives and narcotics detector products while continuing to make significant investments in developing the next generation of these products.

Liquidity, Going Concern and Managements Plans

On December 10, 2008, we entered into a note and warrant purchase agreement with DMRJ Group LLC (DMRJ) 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 March 19, 2015, we amended our credit agreements with DMRJ pursuant to which, amongst other matters, we extended the maturity date of all of our indebtedness from March 31, 2015 to March 31, 2016.

On May 4, 2015, we entered into an assignment agreement with DMRJ and Montsant Partners, LLC, wherein DMRJ assigned its rights, title and interest in the senior secured promissory note dated December 10, 2008 and appointed DMRJ as its collateral agent under the promissory note agreement. The note matures on March 31, 2016. DMRJ and Montsant Partners, LLC are funds managed by Platinum Partners Value Arbitrage Fund LP.

 On March 19, 2014, we entered into a note purchase agreement with a group of institutional investors and BAM Administrative Services LLC (BAM), an administrative agent for the investors, pursuant to which we issued senior secured promissory notes in the aggregate principal amount of $20,000,000. The notes bear interest at 16% per annum and mature on March 31, 2016.  We used all of the proceeds from the sale of the notes to repay (i) $17,624,000 of our outstanding indebtedness to DMRJ under revolving promissory note (ii) $1,809,000 of interest outstanding under that facility and (iii) $567,000 of interest outstanding under our senior secured convertible promissory note (see Note 13).

On December 11, 2015, we entered into an Accounts Receivable Purchase Agreement (the Purchase Agreement) with Republic Capital Access, LLC (RCA), pursuant to which we may sell eligible accounts receivables relating to U.S. government prime contracts or subcontracts (as defined in the Purchase Agreement, Eligible Receivables) to RCA.  The total amount of Eligible Receivables that we may sell to RCA is subject to a maximum limit of $2,000,000 of outstanding receivables (the Maximum Amount) at any given time.  The Purchase Agreement terminates on November 30, 2016.

Despite our current sales, expense and cash flow projections and $3,084,000 in cash available from our line of credit with DMRJ, at February 5, 2016, to fund our operations and continue the development, commercialization and marketing of our products will require that we extend our note agreements with DMRJ, BAM and Monstant. There can be no assurance that DMRJ will continue to make advances under our revolving line of credit. 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.

Our common stock was delisted by the NYSE Amex LLC in June 2009 as a result of our failure to comply with certain continued listing requirements.  Our common stock has been quoted on the OTC Bulletin Board since May 2009 and is also quoted on the OTC Markets Groups OTCQB tier under the symbol IMSC. We believe that trading over the counter has limited our stocks liquidity and has impaired our ability to raise capital.

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 six months ended December 31, 2015, we reported a net loss of approximately $4,224,000 and approximately used $1,373,000 in cash for operations.  As of December 31, 2015, the Company had an accumulated deficit of approximately $193,653,000 and a working capital deficit of approximately $81,621,000.  Management continually evaluates operating expenses and cash flow from operations.  Failure of the Company to achieve its projections will require that we seek additional financing or discontinue operations.



6



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


As of December 31, 2015, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $12,000,000, $12,000,000, $1,000,000 and $16,862,000, respectively. Further, as of December 31, 2015, our obligation to DMRJ for accrued interest under these instruments approximated $14,559,000 and is included in accrued expenses in the condensed consolidated financial statements.

As of December 31, 2015, our obligations to Montsant under a promissory note approximated $3,184,000. Further, as of December 31, 2015, our obligation to Montsant for accrued interest under this instrument approximated $1,860,000 and is included in accrued expenses in the condensed consolidated financial statements.

On September 24, 2015, Montsant converted $245,000 of the accrued interest owed by us under a promissory note into 3,062,500 shares of our common stock, at an adjusted conversion price of $0.08 per share.

As of December 31, 2015, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of December 31, 2015, our obligation under such notes for accrued interest amounted to approximately $1,690,000 and is included in accrued expenses in the condensed consolidated financial statements.

As of February 5, 2016, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $12,000,000, $12,000,000, $1,000,000 and $16,862,000, respectively. Further, as of February 5, 2016, our obligation to DMRJ for accrued interest under these instruments approximated $15,187,000.

As of February 5, 2016, our obligations to Montsant under a promissory note approximated $3,184,000. Further, as of February 5, 2016, our obligation to Montsant for accrued interest under this instrument approximated $1,907,000.

As of February 5, 2016, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of February 5, 2016, our obligation under such notes for accrued interest amounted to approximately $2,010,000.

These conditions raise substantial doubt as to our ability to continue as a going concern.

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 that we 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.  Further, upon the occurrence of an event of default under certain provisions of our credit agreements, we could be required to pay default rate interest equal to the lesser of 2.5% per month and the maximum applicable legal rate per annum on the outstanding principal balance outstanding. The failure to refinance or otherwise negotiate further extensions of our obligations to our secured lenders 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.

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, provided that our credit facilities are extended. These plans depend on a substantial increase in sales of our handheld trace explosives detector product and our desktop explosives and narcotics trade detector product and on the extension of the maturity date of our credit facilities with DMRJ, BAM and Montsant.  However, there can be no assurances that sales will materialize as forecasted, and/or that management will be successful in refinancing or extending our obligations to our secured lenders, which mature on March 31, 2016. 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. 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.






7



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 consolidated 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.

Security product sales tend to have a long sales cycle, and are often subject to export controls.  In an effort to identify new opportunities and stimulate sales, we  hired additional sales personnel during fiscal 2013 that have specific industry experience and have retained new distributors. 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 recorded no revenues from government grants or contracts, due to the expiration of several contracts and our inability to secure new 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.

On October 16, 2014, the U.S. Department of Homeland Security (DHS) selected our proposal to develop next generation explosives trace detection screening systems for funding under a statement of work. The project, pending successful negotiations, is potentially worth up to approximately $2 million. Subject to successful conclusion of negotiations with the DHS, we expect the project to commence in the fourth of quarter of fiscal 2016.

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

2.

Interim Financial Statements and Basis of Presentation

Principles of Consolidation

The accompanying condensed consolidated financial statements include our operations in Massachusetts, our former facilities in California and Shanghai, China, and those of our wholly-owned subsidiaries. On March 25, 2015, our Board of Directors approved restructuring actions to better align costs with current and future geographic revenue sources and to improve efficiencies.  Our San Diego, CA advanced technology office was relocated to our Wilmington, MA facility and our Shanghai office was closed. All intercompany transactions and accounts have been eliminated in consolidation.

Accounting Principles

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. The results of operations and cash flows for the six months ended December 31, 2015 may not necessarily be indicative of results that may be expected for any succeeding quarter or for the entire fiscal year. The balance sheet at December 31, 2015 has been derived from our audited consolidated financial statements at that date, but does not include all of the information and notes required by U.S. GAAP for complete financial statements.



8



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


The information contained in this Form 10-Q should be read in conjunction with our audited financial statements, included in our Form 10-K, as of and for the year ended June 30, 2015.

Use of Accounting Estimates

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

Significant accounting policies are described in Note 2 to the consolidated financial statements included in Item 7 of our Form 10-K for the fiscal year ended June 30, 2015.

Foreign Currency Translation

The assets and liabilities of our Shanghai representative office were translated into U.S. dollars at current exchange rates as of the balance sheet date; expenses were translated at average monthly exchange rates. Net unrealized translation gains or losses associated with the Shanghai office were recorded directly to other comprehensive income. Realized gains and losses from foreign currency transactions were not material for any of the periods presented. We had short-term inter-company receivables from our Shanghai office which were adjusted each period for changes in foreign currency exchange rates with a corresponding entry recorded as a component of the condensed consolidated statement of operations and comprehensive loss.

Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. The FASB issued ASU 2014-09 to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards. The core principle of this updated guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new rule also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This guidance is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods therein, which is effective for our fiscal year beginning July 1, 2018, the first day of our 2019 fiscal year. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

In June 2014, the FASB issued Accounting Standards Update 2014-12, Compensation-Stock Compensation (ASU 2014-12). The FASB issued ASU 2014-12 to provide specific guidance on share-based payment awards that provide for achievement of a specific performance target that could be achieved after the requisite service period. ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period should be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. This guidance is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, which is effective for our fiscal year beginning July 1, 2016, the first day of our 2017 fiscal year. Earlier adoption is permitted. ASU 2014-12 may be applied prospectively to all awards granted or modified after the effective date or retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. If retrospective transition is adopted, the cumulative effect of applying this guidance should be recognized in the financial statements as an adjustment to the opening retained earnings balance at that date. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.



9



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


In August 2014, the FASB issued Accounting Standards Update 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40) (ASU 2014-15). ASU 2014-15 provides guidance to U.S. GAAP about managements responsibility to evaluate whether there is a substantial doubt about an entitys ability to continue as a going concern and to provide related footnote disclosures. This new rule requires management to assess an entitys ability to continue as a going concern by incorporating and expanding upon certain principles currently in U.S. auditing standards. Specifically, ASU 2014-15 (1) defines the term substantial doubt, (2) requires an evaluation of every reporting period including interim periods, (3) provides principles for considering the mitigating effect of managements plan, (4) requires certain disclosures when substantial doubt is alleviated as a result of consideration of managements plans, (5) requires an express statement and other disclosures when substantial doubt is not alleviated, and (6) requires an assessment for a period of one year after the date that the financial statements are issued. This guidance is effective for annual periods ending after December 15, 2016, which is effective for our fiscal year beginning July 1, 2016, the first day of our 2017 fiscal year. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

In July 2015, the FASB issued Accounting Standards Update 2015-11, Inventory (Topic 330) (ASU 2015-11). ASU 2015-11 was issued to more closely align the measurement of inventory in U.S. GAAP with the measurement of inventory in International Financial Reporting Standards. The core principle of this updated   guidance is that an entity should measure inventory at the lower of cost or net realizable value.  Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments in ASU 2015-11 apply to inventory that is measured using the first-in, first-out or average cost methods. ASU 2015-11 amends some of the guidance in Topic 330 to more clearly articulate the requirements for the measurement and disclosure of inventory, but the clarifications are not intended to result in any changes in practice other than the change in the subsequent measurement guidance from the lower of cost or market to the lower of cost or net realizable value for inventory.  There are no other substantive changes to the guidance on the measurement of inventory. This guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, which is effective for our fiscal year beginning July 1, 2017, the first day of our 2018 fiscal year. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

In August 2015, the FASB issued Accounting Standards Update 2015-15, Interest Imputation of Interest (Subtopic 835-30) Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements (ASU 2015-15). ASU 2015-15 states that Staff at the Securities and Exchange Commission would not object to an entity deferring or presenting debt issuance costs as an asset and subsequently amortizing deferred debt issuance cost ratably over the term of the line-of-credit arrangement, regardless of whether there were outstanding borrowings under the arrangement. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

3.

Fair Value Measurement

Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures, establishes a three-level fair value hierarchy to classify the inputs used in measuring fair value, which are as follows:

Level 1 inputs to the valuation methodology are based on quoted prices (unadjusted) in active markets for identical assets or liabilities;

Level 2 inputs to the valuation methodology are based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and

Level 3 inputs to the valuation methodology are based on unobservable inputs that reflect the companys own assumptions about the assumptions market participants would use in pricing the asset or liability.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Our financial instruments at December 31, 2015 and June 30, 2015 include cash equivalents, restricted cash, accounts receivable, accounts payable and borrowings under our senior secured convertible promissory note, senior secured promissory note and a revolving line of credit. The carrying amounts of cash and cash equivalents, restricted cash, receivables, and accounts payable are representative of their respective fair values because of the short-term maturities or expected settlement dates of these instruments. The fair value of debt, included in Note 13, is based on the fair value of similar instruments. These instruments are short-term in nature and there is no known trading market for our debt 



10



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


 

The following table provides the non-recurring fair value measurements of assets and liabilities as of December 31, 2015:






Fair Value Measurements as of

December 31, 2015

Description (In thousands)


Carrying

Value at

December 31, 2015


Quoted Prices in Active Markets for Identical Asset

Level 1


Significant Other Observable Inputs

Level 2


Significant Unobservable Inputs

Level 3

Certificates of deposit


$

312


$

312


$

-


$

-

Senior secured promissory note BAM


20,000


-


-


20,000

Senior secured convertible promissory note Montsant


3,184


-


-


3,184

Second senior secured convertible promissory note DMRJ


12,000


-


-


12,000

Third senior secured convertible promissory note DMRJ


12,000


-


-


12,000

Senior secured promissory note - DMRJ


1,000


-


-


1,000

Line of credit - DMRJ


16,862


-


-


16,862

The following table provides the non-recurring fair value measurements of assets and liabilities as of June 30, 2015:





Fair Value Measurements as of

June 30, 2015

Description (In thousands)


Carrying

Value at

June 30, 2015


Quoted Prices in Active Markets for Identical Asset

Level 1


Significant Other Observable Inputs

Level 2


Significant Unobservable Inputs

Level 3

Certificates of deposit


$

312


$

312


$

-


$

-

Senior secured promissory note BAM


20,000


-


-


20,000

Senior secured convertible promissory note Montsant


3,184


-


-


3,184

Senior secured promissory note - DMRJ


1,000


-


-


1,000

Second senior secured convertible promissory note DMRJ


12,000


-


-


12,000

Third senior secured convertible promissory note DMRJ


12,000


-


-


12,000

Line of credit - DMRJ


16,662


-


-


16,662






 

11



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


4.     Restricted Cash and Investments

As of December 31, 2015 and June 30, 2015, we had restricted cash and investments, with maturities of less than one year, of $367,000. Restricted cash and investments consisted of the following:

(In thousands)


December 31,

2015


June 30,

2015

Current assets





Certificates of deposit


$

312


$

312

Cash maintained to secure corporate credit card


55


55

Total


$

367


$

367

The restricted investments of $312,000 held in certificates of deposit collateralize our performance under an irrevocable letter of credit issued in April 2010, aggregating to $297,000, in connection with our contract with the India Ministry of Defence, plus the bank required collateralization deposit of $15,000. The letter of credit provides warranty performance security equal to 5% of the contract amount under the terms of the contract with the India Ministry of Defence. We have amended the letter of credit, extending the expiration date to May 28, 2016.

In May 2015, we entered into a corporate credit card agreement with our primary bank, pursuant to which the bank reserves $55,000 of the available cash held in our operating account maintained with the bank to collateralize 105% of the credit limit that is available under the credit card agreement.

5.

Stock Based Compensation

For the three months ended December 31, 2015 and 2014, our condensed consolidated statements of operations and comprehensive loss include $326,000 and $535,000, respectively, of compensation costs and no income tax benefit related to our stock-based compensation arrangements for employee and non-employee director awards. For the six months ended December 31, 2015 and 2014, our condensed consolidated statements of operations and comprehensive loss include $668,000 and $1,227,000, respectively, of compensation costs and no income tax benefit related to our stock-based compensation arrangements for employee and non-employee director awards, as follows:




For the Three Months Ended

December 31,


For the Six Months Ended

December 31,

(In thousands)


2015


2014


2015


2014

Cost of revenues


$

31


$

53


$

61


$

101

Research and development


46


120


130


242

Selling, general and administrative


249


362


477


884

Total


$

326


$

535


$

668


$

1,227


As of December 31, 2015, the total amount of unrecognized stock-based compensation expense was approximately $1,741,000, which will be recognized over a weighted average period of 1.66 years.

As of December 31, 2015, there were options outstanding to purchase 21,076,651 shares of our common stock at exercise prices ranging from $0.08 to $2.30, with a weighted-average exercise price of $1.14.

6.

Related Party Transactions

In April 2011, we entered into an advisory and consulting agreement with Robert Liscouski, our President and a member of our Board of Directors, to assist our U.S. government sales and marketing team with our efforts to advance our interests with the U.S. government. During the three and six months ended December 31, 2014, we paid Mr. Liscouski $60,000 and $105,000, respectively for services performed under this agreement which terminated effective on February 1, 2015, when Mr. Liscouski joined the Company. As of December 31, 2015, we had no obligation to Mr. Liscouski under this agreement.





12



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


On August 15, 2014, August 29, 2014, September 18, 2014 and October 2, 2014, Roger Deschenes, our Chief Financial Officer, advanced $100,000, $125,000, $125,000 and $100,000, respectively, for general working capital purposes, of which $450,000 of principal and $12,000 of interest has been repaid to Mr. Deschenes during the fiscal year ended June 30, 2015. The advances were payable on demand and bore interest at 15%. As of December 31, 2015 our obligation to Mr. Deschenes was $0.

7.

Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist of the following:

(In thousands)


December 31,

2015


June 30,

2015

Inventory deposits


$

280


$

677

Insurance


58


87

Bank fees


6


14

Other prepaid expenses


147


168

Total


$

491


$

946


8.

Inventories, net

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. The components of inventories, net of reserves, consist of the following:


(In thousands)


December 31,

2015


June 30,

2015

Raw materials


$

3,895


$

3,283

Work in progress


1,418


1,455

Finished goods


1,410


506

Total


$

6,723


$

5,244

As of December 31, 2015 and June 30, 2015, our reserves for excess and slow-moving inventories were $213,000 and $218,000, respectively.

9.

Property and Equipment, net

Property and equipment consist of the following:

(In thousands)


December 31,

2015


June 30,

2015

Machinery and equipment


$

553


$

533

Computers and software


432


415

Furniture and fixtures


91


83

Leasehold improvements


173


159

Equipment under capital lease


159


157

Construction in progress


342


342

Sub-total


1,750


1,689

Less: accumulated depreciation and amortization


909


809

Total


$

841


$

880

For the three months ended December 31, 2015 and 2014, depreciation expense was approximately $50,000 and $40,000, respectively.  

For the six months ended December 31, 2015 and 2014, depreciation expense was approximately $104,000 and $81,000, respectively.

13



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


10.    Accrued Expenses Current and Long-Term

Accrued expenses consist of the following:

(In thousands)


December 31,

2015


June 30,

2015

Current liabilities





Accrued interest


$

18,108


$

13,264

Accrued compensation and benefits


3,299


1,774

Accrued warranty costs


1,337


556

Accrued legal and accounting


52


257

Accrued taxes


146


74

Other accrued liabilities


1,817


1,155

Total


$

24,759


$

17,080






Long-term liabilities





Accrued compensation and benefits


$

-


$

48



$

-


$

48

On January 16, 2015, Glenn D. Bolduc, resigned his positions as Chief Executive Officer and President of the Company), as well as his seat on the Companys Board of Directors and his position as Chairman of the Board. In connection with and prior to Mr. Bolducs resignations, Mr. Bolduc entered into a Separation Agreement and Release (the Separation Agreement) with the Company.  The Separation Agreement provides that Mr. Bolducs resignation will be deemed an involuntary termination without cause pursuant to his Amended and Restated Employment Agreement dated as of June 25, 2013.  In this regard, and subject to the terms contained in the Employment Agreement, Mr. Bolduc is entitled to receive: (i) annual base salary for 18 months on a regular payroll basis; (ii) a pro rata portion of any bonus earned in 2015; (iii) continuation of coverage under and contributions to health care, dental and life insurance benefits for a 12 month period; and (iv) transfer of any key man life insurance.  In connection with Mr. Bolducs resignation, we recorded a non-recurring charge of $725,000 in our consolidated statements of operations and comprehensive loss for the year ended June 30, 2015.  As of December 31, 2015 and June 30, 2015, $327,000 and $480,000, respectively, of separation benefits are included in accrued expenses in our condensed consolidated financial statements.

11.

Deferred Revenues Current and Long-Term

Deferred revenues are recorded when we receive payments for product or services for which we have not yet completed our obligation to deliver product or have not completed services required by the contractual agreements.

As of December 31, 2015 and June 30, 2015, we had customer advance payment and extended warranty service agreements with maturities of less than one year, of $1,466,000 and $3,454,000, respectively, and extended warranty service agreements, with maturities of more than one year, of $355,000 and $221,000, respectively. Deferred revenues consisted of the following:

(In thousands)


December 31,

2015


June 30,

2015

Current liabilities





Customer advance payments


$

1,033


$

3,121

Extended warranty service agreements


433


333

Total


$

1,466


$

3,454


Long-term liabilities





Extended warranty service agreements


$

355


$

221

Total


$

355


$

221




 

14



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


12.    Earnings Per Share

Basic earnings per share is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted earnings per share are based upon the weighted average number of common shares outstanding during the period plus additional weighted average common equivalent shares outstanding during the period. Common equivalent shares result from the assumed exercise of outstanding stock options and warrants, the proceeds of which are then assumed to have been used to repurchase outstanding common stock using the treasury stock method and assumed conversion of certain convertible promissory notes and convertible preferred stock. In addition, the numerator is adjusted for any changes in income or loss that would result from the assumed conversion of potential shares. As of December 31, 2015 and 2014, potentially dilutive shares are excluded from the earnings per share calculation, because their effect would be antidilutive. Shares deemed to be antidilutive include stock options, warrants, convertible debt and convertible preferred stock.



For the Three Months Ended

December 31,


For the Six Months Ended

December 31,

(In thousands, except share and per share amounts)


2015


2014


2015


2014

Basic and diluted loss per share:









Numerator:









Net loss


$

(3,313)


$

(6,244)


$

(4,224)


$

(11,619)

Denominator:









Weighted average shares


78,528,620 


70,938,120 


77,367,787 


67,842,872 

Basic and diluted loss per share


$

(0.04)


$

(0.09)


$

(0.05)


$

(0.17)

Common stock equivalents excluded from the diluted earnings per share calculation for the three and six months ended December 31, 2015 and 2014, were as follows:




For the Three Months Ended

December 31,


For the Six Months Ended

December 31,



2015


2014


2015


2014

Common stock equivalents excluded









   Stock options


556,561


2,141,637


686,859


2,406,659

   Warrants


-


579,207


32,396


689,052

   Convertible debt


39,800,000


60,978,666


39,800,000


60,978,666



40,356,561


63,699,510


40,519,255


        64,074,377


13.

Long-Term Debt and Credit Arrangements

Term Debt and Revolving Credit Facility with DMRJ Group, LLC and Term Debt with Montsant Partners, LLC

We are a party to several loan and credit agreements with DMRJ Group LLC (DMRJ), an accredited institutional investor. In December 2008, we entered into a note and warrant purchase agreement with DMRJ 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.  Thereafter, we entered into a series of amendments, waivers and modifications of this facility. The note, which is collateralized by all of our assets, originally bore interest at 11.0% per annum.

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 or indebtedness; 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



15



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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.

In September 2011, we amended each of our credit instruments with DMRJ. Pursuant to those amendments: (i) the maturity of our indebtedness to DMRJ was extended from September 30, 2011 to March 31, 2013; (ii) DMRJ waived our compliance with certain financial covenants in the notes and all related credit agreements through maturity; (iii) our line of credit under the September 2009 credit agreement was increased from $15,000,000 to $23,000,000; and (iv) we were required to repay sufficient amounts of our outstanding indebtedness under the notes and related credit agreements and other amounts owing to DMR such that as of December 31, 2011, the outstanding obligations to DMRJ shall not exceed $15,000,000.

In October 2011, we further amended each of our credit instruments with DMRJ, to eliminate the obligation to repay any portion of our outstanding indebtedness to DMRJ by December 31, 2011.

In February 2012, we amended each of our credit instruments with DMRJ, to extend the maturity of all of our indebtedness to DMRJ to September 30, 2012.

In September 2012, we further amended each of our credit instruments with DMRJ. Pursuant to those amendments: (i) we extended the maturity date of all of our indebtedness from September 30, 2012 to March 31, 2013 and (ii) issued to DMRJ a second senior secured convertible promissory note in the principal amount of $12,000,000 (the September 2012 Note).

The second senior secured convertible promissory note bears interest at the rate of 15% per annum. The principal balance of this note, together with all outstanding interest and all other amounts owed thereunder, was due and payable on March 31, 2013. The second senior secured convertible promissory note is convertible in whole or in part, at DMRJs option, into shares of Series H Convertible Preferred Stock at an initial conversion rate of $1,000 per share (as adjusted in the event of any stock dividend, stock split, combination or other similar recapitalization with respect to the Series H Preferred Stock, the Series H Original Issue Price).

The second senior secured convertible promissory note originally gave DMRJ the option to require us to repurchase any or all of the shares of Series H Preferred Stock owned by DMRJ, at the Series H Original Issue Price per share, if we did not (i) by March 31, 2013, have at least one of our products receive qualified or approved status on the Transportation Security Administration Air Cargo Screening Technology List (ACSTL) For Passenger Aircraft or placed on the Transportation Security Administrations Explosive Trace Detector Qualified Product List (QPL); or (ii) achieve revenues of at least $7,500,000 per fiscal quarter, commencing with fiscal quarter ending June 30, 2013. As described below, the note was subsequently amended to eliminate this option.

The holders of the Series H Preferred Stock will be entitled to receive, prior to the payment of any dividends with respect to our Common Stock and/or Series G Convertible Preferred Stock, cumulative dividends on each share of Series H Preferred Stock at a rate equal to 15% of the Series H Original Issue Price per annum, (i) when, as and if declared by our Board of Directors, (ii) upon a liquidation, dissolution or winding up of the Company (a Liquidation Event), or (iii) upon the repurchase or conversion of the Series H Preferred Stock All dividends accruing on the Series H Preferred Stock are payable by the issuance of additional shares of Series H Preferred Stock.

Upon a Liquidation Event, the holders of shares of Series H Preferred Stock then outstanding will be entitled to be paid out of the assets of the company available for distribution to its stockholders, before any payment is made to the holders of Common Stock and/or Series G Preferred Stock in respect of such stock, an amount per share equal to the Series H Original Issue Price, plus any accrued but updated dividends thereon, whether or not declared. At the option of holders of a majority of the outstanding Series H Preferred Stock, (i) a consolidation or merger of us with or into another entity or person, or any other corporate reorganization, in which our stockholders immediately prior to such consolidation, merger or reorganization do not hold at least a majority of the resulting or surviving entities voting power immediately following such consolidation, merger or reorganization, or (ii) a sale or transfer of all or substantially all of our assets for cash, securities or other property, will be deemed to be a Liquidation Event.

Each share of Series H Preferred Stock will be convertible, at the option of the holder, into that number of shares of Common Stock as is determined by (i) dividing the Series H Original Issue Price by the Series H Conversion Price (as defined below) in effect at the time of conversion and (ii) multiply the result by 1,000. The Series H Conversion



16



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Price will initially be equal to $1,090, and is subject to adjustment in the event that (a) we issue additional shares of Common Stock as a dividend or other distribution on outstanding shares of Common Stock, (b) there is a split or subdivision of outstanding shares of Common Stock, or (c) there is a combination or reverse stock split of outstanding shares of Common Stock into a smaller number of shares of Common Stock. Assuming no adjustments to the Series H Original Issue Price or the Series H Conversion Price, the New Note will be convertible indirectly, at DMRJs option, into shares of Common Stock at an effective conversion price of $1.09 per share, which represents a discount of approximately 20% from the daily volume weighted average price of the Common Stock over the 20 trading days preceding the date of the amendment.

The holders of the Series H Preferred Stock will have no voting rights except as required by applicable law. However, without the consent of the holders of a majority of the outstanding Series H Preferred Stock, we may not (i) amend, alter or repeal any provision of its Articles of Organization or By-laws in a manner that adversely affects the powers, preferences or rights of the Series H 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 H 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 its equity securities (or debt securities convertible into equity securities) into equity securities ranking prior and superior to the Series H Preferred Stock with respect to dividends, distributions, redemption rights or rights upon liquidation, dissolution or winding up.

On February 28, 2013, we further amended each of our credit instruments with DMRJ. Pursuant to those amendments:

·

the maturity of all of our indebtedness to DMRJ was extended from March 31, 2013 to March 31, 2014;

·

DMRJ waived our compliance with certain financial covenants in each of our promissory notes and all related credit agreements through the new maturity date;

·

DMRJs option to require us to repurchase any or all of the shares of Series H Convertible Preferred Stock ) which may be issued upon conversion of the September 2012 Note was eliminated;

·

we issued to DMRJ a third senior secured convertible promissory note dated February 28, 2013, in the aggregate principal amount of $12,000,000. Payment for the February 2013 Note was made by the cancellation of $12,000,000 of principal of the outstanding indebtedness under our credit agreement;

·

DMRJ acquired the option to convert the amended and restated senior secured convertible promissory note dated March 12, 2012 (the March 2012 Note) into shares of Series J Convertible Preferred Stock in lieu of shares of Common Stock; and

·

the March 2012 Note and the September 2012 Note were amended to permit us to prepay any or all of our indebtedness thereunder on 30 days prior notice.

The third senior secured convertible promissory note bears interest at the rate of 15% per annum. The principal balance of this note, together with all outstanding interest and all other amounts owed thereunder, were due and payable on March 31, 2015. The third senior secured convertible promissory note is convertible in whole or in part, at DMRJs option, into shares of Series I Convertible Preferred Stock at an initial conversion rate of $1,000 per share (as adjusted in the event of any stock dividend, stock split, combination or other similar recapitalization with respect to the Series I Preferred Stock, the Series I Original Issue Price). We may prepay this note on 30 days prior notice.

As amended, the March 2012 Note is convertible in whole or in part, at DMRJs option, into shares of Series J Convertible Preferred Stock at an initial conversion rate of $1,000 per share (as adjusted in the event of any stock dividend, stock split, combination or other similar recapitalization with respect to the Series J Preferred Stock, the Series J Original Issue Price).

The holders of the Series I Preferred Stock will be entitled to receive, prior to the payment of any dividends with respect to our Common Stock and/or Series G Preferred Stock, cumulative dividends on each share of Series I Preferred Stock at a rate equal to 15% of the Series I Original Issue Price per annum, (i) when, as and if declared by our Board of Directors, (ii) upon a Liquidation Event, or (iii) upon the conversion of the Series I Preferred Stock All dividends accruing on the Series I Preferred Stock are payable by the issuance of additional shares of Series I Preferred Stock.

The holders of Series J Preferred Stock will be entitled to participate on an as converted basis in all dividends or distributions declared or paid on our Common Stock.



17



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Upon a Liquidation Event, the holders of shares of Series I Preferred Stock and Series J Preferred Stock then outstanding will be entitled to be paid out of the assets of the company available for distribution to its stockholders, pari passu with distributions made with respect to the Series H Preferred Stock but before any payment is made to the holders of Common Stock and /or Series G Preferred Stock in respect of such stock, (i) an amount per share of Series I Preferred Stock equal to the Series I Original Issue Price, plus any accrued but updated dividends thereon, whether or not declared, and (ii) an amount per share of Series J Preferred Stock equal to the Series J Original Issue Price, plus any dividends declared but unpaid thereon. At the option of holders of a majority of the outstanding Series I Preferred Stock, (i) a consolidation or merger of the company with or into another entity or person, or any other corporate reorganization, in which the stockholders of the company immediately prior to such consolidation, merger or reorganization do not hold at least a majority of the resulting or surviving entities voting power immediately following such consolidation, merger or reorganization, or (ii) a sale or transfer of all or substantially all of our assets for cash, securities or other property, will be deemed to be a Liquidation Event.

Upon any such Liquidation Event, and after all payments described in the preceding paragraph are made in full in respect of the Series H Preferred Stock, the Series I Preferred Stock and the Series J Preferred Stock, the holders of the Series G Preferred Stock will be entitled to be paid out of the assets of the company available for distribution to its stockholders an amount equal to $8.00 per share of Series G Preferred Stock, plus any declared but unpaid dividends, prior to the payment of any amounts to the holders of our Common Stock by reason of their ownership of such stock.

Each share of Series I Preferred Stock will be convertible, at the option of the holder, into that number of shares of Common Stock as is determined by (i) dividing the Series I Original Issue Price by the Series I Conversion Price (as defined below) in effect at the time of conversion and (ii) multiplying the result by 1,000. The Series I Conversion Price will initially be equal to $1,180.00, and is subject to adjustment in the event that (a) we issue additional shares of Common Stock as a dividend or other distribution on outstanding shares of Common Stock, (b) there is a split or subdivision of outstanding shares of Common Stock, or (c) there is a combination or reverse stock split of outstanding shares of Common Stock into a smaller number of shares of Common Stock. Assuming no adjustments to the Series I Original Issue Price or the Series I Conversion Price, the February 2013 Note will be convertible indirectly, at DMRJs option, into shares of Common Stock at an effective conversion price of $1.18 per share, which represents premium of approximately 3% over the closing price of the Common Stock on the trading day preceding the date of the February 28, 2013 amendments.

Each share of Series J Preferred Stock will be convertible, at the option of the holder, into that number of shares of Common Stock as is determined by dividing the Series J Original Issue Price by the Series J Conversion Price (as defined below) in effect at the time of conversion. The Series J Conversion Price will initially be equal to $.08, and is subject to adjustment in the event that (a) the Company issues additional shares of Common Stock as a dividend or other distribution on outstanding shares of Common Stock, (b) there is a split or subdivision of outstanding shares of Common Stock, or (c) there is a combination or reverse stock split of outstanding shares of Common Stock into a smaller number of shares of Common Stock. Assuming no adjustments to the Series J Original Issue Price or the Series J Conversion Price, the March 2012 Note will be convertible indirectly, at DMRJs option, into shares of Common Stock at an effective conversion price of $.08 per share. Prior to the execution of the amendment, the March 2012 Note was convertible directly into shares of Common Stock at a conversion price of $.08 per share. Accordingly, we do not believe this change to be material.

The holders of the Series I Preferred Stock and the Series J Preferred Stock will have no voting rights except as required by applicable law. However, without the consent of the holders of a majority of the outstanding Series I Preferred Stock or Series J Preferred Stock, as the case may be, with each such series voting as a separate class, we may not (i) amend, alter or repeal any provision of our Articles of Organization or By-laws in a manner that adversely affects the powers, preferences or rights of the Series I Preferred Stock or Series J Preferred Stock, as the case may be; (ii) authorize or issue any equity securities (or any equity or debt securities convertible into equity securities) ranking prior and superior to the Series I Preferred Stock or Series J Preferred Stock, as the case may be, 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 its equity securities (or debt securities convertible into equity securities) into equity securities ranking prior and superior to the Series I Preferred Stock or Series J Preferred Stock, as the case may be, with respect to dividends, distributions, redemption rights or rights upon liquidation, dissolution or winding up.



18



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


As of December 31, 2015, there were no shares of Series H Preferred Stock, Series I Preferred Stock or Series J Preferred Stock outstanding.

On November 14, 2013, we amended each of our credit agreements with DMRJ to extend the maturity date of all of our indebtedness to DMRJ from March 31, 2014 to September 30, 2014.

On March 19, 2014, we further amended each of our credit instruments with DMRJ. Pursuant to those amendments:

·

the maturity of all of our indebtedness to DMRJ was extended from September 30, 2014 to March 31, 2015;

·

DMRJ waived our compliance with certain financial covenants in each of our promissory notes and all related credit agreements through the new maturity date;

·

DMRJ consented to the execution and delivery of the note purchase agreement with BAM and agreed to waive all prepayment limitations and prepayment notice requirements set forth in any of the credit documents to which DMRJ and the company are parties with respect to the repayments and prepayments financed by the sale of the notes.

·

DMRJ agreed to subordinate its first position security interest in all of our assets to BAM.

On March 19, 2015, we further amended each of our credit instruments with DMRJ, pursuant to which the maturity of all our indebtedness to DMRJ was extended from March 31, 2015 to March 31, 2016 and DMRJ waived our compliance with certain financial covenants contained in each of our promissory notes and all related credit agreements through the new maturity date.

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 2.5% per month and the maximum applicable legal rate per annum on the outstanding principal balance outstanding.

On May 4, 2015, we entered into an assignment agreement with DMRJ and Montsant Partners, LLC, wherein DMRJ assigned its rights, title and interest in the senior secured promissory note dated December 10, 2008 and appointed DMRJ as its collateral agent under the promissory note agreement. The note matures on March 31, 2016. DMRJ and Montsant Partners, LLC are funds managed by Platinum Partners Value Arbitrage Fund LP.

As of December 31, 2015, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $12,000,000, $12,000,000, $1,000,000 and $16,862,000, respectively. Further, as of December 31, 2015, our obligation to DMRJ for accrued interest under these instruments approximated $14,559,000 and is included in accrued expenses in the condensed consolidated financial statements.

As of February 5, 2016, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $12,000,000, $12,000,000, $1,000,000 and $16,862,000, respectively. Further, as of February 5, 2016, our obligation to DMRJ for accrued interest under these instruments approximated $15,187,000.

The note purchase agreement with Montsant 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, against the sale, assignment, transfer or lease of our assets, other than in the inventory ordinary course of business; 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 maintain a minimum cash balance of at least $500,000; that the weighted average age 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. Montsant waived our compliance with certain financial covenants in our promissory notes through the maturity date, consistent with the financial covenants which have been waived in each of our promissory notes and all related credit agreements with DMRJ.

Further, upon the occurrence of an event of default under certain provisions of our agreement with Montsant, we could be required to pay default rate interest equal to the lesser of 2.5% per month and the maximum applicable legal rate per annum on the outstanding principal balance outstanding.

As of December 31, 2015, our obligations to Montsant under a promissory note approximated $3,184,000. Further, as of December 31, 2015, our obligation to Montsant for accrued interest under this instrument approximated $1,860,000 and is included in accrued expenses in the condensed consolidated financial statements



19



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


On September 24, 2015, Montsant converted $245,000 of the accrued interest owed by us under a promissory note into 3,062,500 shares of our common stock, at an adjusted conversion price of $0.08 per share.

As of February 5, 2016, our obligations to Montsant under a promissory note approximated $3,184,000. Further, as of February 5, 2016, our obligation to Montsant for accrued interest under this instrument approximated $1,907,000.

Term Debt with BAM

On March 19, 2014, we entered into a note purchase agreement with a group of institutional investors and BAM Administrative Services LLC (BAM), an administrative agent for the investors, pursuant to which we issued senior secured promissory notes in the aggregate principal amount of $20,000,000. The notes bear interest at 15% per annum and mature on March 31, 2015.  The proceeds from the sale of the notes were used to repay (i) $17,624,000 of our outstanding indebtedness to DMRJ under the amended and restated revolving promissory note dated September 29, 2011 (ii) $1,809,000 of interest outstanding under the amended and restated promissory note and (iii) $567,000 of interest outstanding under our senior secured convertible promissory note dated September 5, 2012.

On March 19, 2015, we extended our credit agreement with BAM pursuant to which, amongst other matters, the interest rate increased to 16% per annum, commencing on April 1, 2015 and we extended the maturity date of our indebtedness from March 31, 2015 to March 31, 2016.

The notes purchase agreement 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, against the sale, assignment, transfer or lease of our assets, other than in the inventory ordinary course of business ; 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 maintain a minimum cash balance of at least $500,000; that the weighted average age 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. BAM waived our compliance with certain financial covenants in our promissory notes through the maturity date, consistent with the financial covenants which have been waived in each of our promissory notes and all related credit agreements with DMRJ.

Further, upon the occurrence of an event of default under certain provisions of our agreements with BAM, we could be required to pay default rate interest equal to the lesser of 2.5% per month and the maximum applicable legal rate per annum on the outstanding principal balance outstanding.

As of December 31, 2015, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of December 31, 2015, our obligation under such notes for accrued interest amounted to approximately $1,690,000 and is included in accrued expenses in the condensed consolidated financial statements.

As of February 5, 2016, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of February 5, 2016, our obligation under such notes for accrued interest amounted to approximately $2,010,000.












 

20



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


14.    Stockholders Deficit

Common Shares Authorized

On July 1, 2015, at an Annual Meeting of Stockholders, our stockholders approved an amendment to the Companys Restated Articles of Organization to increase the number of authorized shares of common stock by 50,000,000 shares to 250,000,000 shares. 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 a result of the stockholder approval, we are authorized to issue 250,000,000 shares of our common stock.

Common Stock Options and Stock Purchase Warrants

In connection with various financing agreements and services provided by consultants, we have issued warrants to purchase shares of our common stock.  The fair value of warrants issued is determined using a binomial option pricing model.  

Common Stock Options

In December 2004, we adopted the 2004 Stock Option Plan (the 2004 Plan). The 2004 Plan provides for the grant of incentive stock options and non-qualified stock options to employees and affiliates. The exercise price of the options equa1 100% of the fair market value on the date of the grant or 110% of the fair market value for beneficial owners of more than 10% of our stock. Options expire between five and ten years from the date of the option grant and have various vesting periods. Options may be exercised by delivering to the company cash in an amount equal to such aggregate exercise price of the options exercised, or with the consent of the Committee, shares of our common stock having a fair market value equal to such aggregate exercise price, a personal recourse note issued to the company in a principal amount equal to such aggregate exercise price, other acceptable consideration including a cashless exercise/resale procedure, or any combination of the foregoing. A total of 500,000 shares were originally reserved for issuance under the 2004 Plan. In December 2005, our stockholders approved an increase in the 2004 Plan from 500,000 shares to 1,000,000 shares.  In December 2007, our stockholders approved an increase in the 2004 Plan from 1,000,000 shares to 2,000,000 shares. In March 2012, our stockholders approved an increase in the 2004 Plan from 2,000,000 shares to 4,000,000. The 2004 Plan expired in May 2014, as such no further options grants may be issued under this plan. In September 2012, our Board of Directors adopted an amendment to our 2004 Stock Option increasing the total number of shares of our common stock issuable thereunder from 4,000,000 shares to 20,000,000 shares. On July 1, 2015, at the 2015 Annual Meeting of Stockholders, the September 2012 amendment was approved by our stockholders.

On July 2, 2014, our Board of Directors adopted the 2014 Stock Option Plan (the 2014 Plan). The 2014 Plan provides for the grant of incentive stock options and non-qualified stock options to employees and affiliates. The exercise price of the options equa1 100% of the fair market value on the date of the grant or 110% of the fair market value for beneficial owners of more than 10% of our stock. Options expire between five and ten years from the date of the option grant and have various vesting periods. Options may be exercised by delivering to the company cash in an amount equal to such aggregate exercise price of the options exercised, or with the consent of the Committee, shares of our common stock having a fair market value equal to such aggregate exercise price, a personal recourse note issued to the company in a principal amount equal to such aggregate exercise price, other acceptable consideration including a cashless exercise/resale procedure, or any combination of the foregoing. A total of 15,000,000 shares were originally reserved for issuance under the 2014 Plan. The 2014 Plan was approved by our stockholders on July 1, 2015 at the 2015 Annual Meeting of Stockholders.

As of December 31, 2015, there were options outstanding to purchase 21,076,651 shares of our common stock at exercise prices ranging from $0.08 to $2.30.

We issued 20,000 and 255,000 shares of common stock during the three months ended December 31, 2015 and 2014, respectively, as a result of the exercise of options by employees and consultants. We issued 83,000 and 488,999 shares of common stock during the six months ended December 31, 2015 and 2014, respectively, as a result of the exercise of options by employees and consultants.





21



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Stock Purchase Warrants and Stock Issuances

In connection with various financing agreements and services provided by consultants, we have issued warrants to purchase shares of our common stock.  The fair value of warrants issued is determined using the Black-Scholes option pricing model.  

In June 2015, we issued 550,000 shares of common stock having a value of $412,000 to two advisors, in consideration of services rendered to us under two advisory and consulting services agreements. The issued shares were valued at the closing stock price of $0.75 per share at May 6, 2015. The advisory and services agreements provide for the issuance of an additional 1,650,000 shares in equal monthly installments of 110,000 shares commencing in September 2015. For the six month ended December 31, 2015, we have issued 440,000 shares of common stock having a value of $331,000 to these two advisors for services rendered under the advisory and consulting services agreement.  

As of December 31, 2015, there were warrants outstanding to purchase 3,155,000, shares of our common stock at exercise prices ranging from $0.54 to $1.22 expiring at various dates between May 25, 2016 and April 1, 2021.

15.

Income Taxes

We are required to file federal and state income tax returns in the United States.  The preparation of these tax returns requires us to interpret the applicable tax laws and regulations in effect in such jurisdictions, which could affect the amount of tax paid by us. In consultation with our tax advisors, we base our tax returns on interpretations that are believed to be reasonable under the circumstances. The tax returns, however, are subject to routine reviews by the various federal and state taxing authorities in the jurisdictions in which we file tax returns. As part of these reviews, a taxing authority may disagree with respect to the income tax positions taken by us (uncertain tax positions) and, therefore, may require us to pay additional taxes. As required under applicable accounting rules, we accrue an amount for our estimate of additional income tax liability, including interest and penalties, which we could incur as a result of the ultimate or effective resolution of the uncertain tax positions. We account for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  A valuation allowance is established when necessary to reduce deferred tax assets to amounts expected to be realized.

We account for uncertain income tax positions by accruing for the estimated additional amount of taxes for the uncertain tax positions when the uncertain tax position does not meet the more likely than not standard for sustaining the position. We review and update our accrual as more definitive information becomes available from taxing authorities, upon completion of tax audits, upon expiration of statutes of limitation, or upon occurrence of other events.  This requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Significant judgment is required in assessing the timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions. The benefits of uncertain tax positions are recorded in our consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge, if any, from tax authorities. When facts and circumstances change, we reassess these probabilities and record any changes in the consolidated financial statements as appropriate.

Deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts and the tax basis of the assets and liabilities using the enacted tax rate in effect in the years in which the differences are expected to reverse.  A valuation allowance has been recorded against the deferred tax asset as it is more likely than not, based upon our analysis of all available evidence, that the tax benefit of the deferred tax asset will not be realized.

A valuation allowance has been established for our tax assets as their use is dependent on the generation of sufficient future taxable income, which cannot be predicted at this time.  Included in the valuation allowance is approximately $800,000 related to certain operating loss carryforwards resulting from the exercise of employee stock options, the tax benefit of which, when recognized, will be accounted for as a credit to additional paid-in capital rather than a reduction in income tax.



22



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


As of December 31, 2015, the Company has the following unused net operating loss and tax credit carryforwards available to offset future federal and state taxable income, both of which expire at various times as noted below:


(In thousands)


Net Operating Losses


Investment AMT & Research Credits


Expiration Dates


Federal


$

107,818


$

1,455


2022 to 2035


State


$

74,879


$

983


2016 to 2035


We have recorded a full valuation allowance against our net deferred tax assets of $49,795,000 as of December 31, 2015, 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.

Potential 382 Limitation

Our net operating loss and tax credit carryforwards are subject to review and possible adjustment by the Internal Revenue Service.  Our ability to utilize our net operating loss (NOL) and alternative minimum tax (AMT) and research and development credit (R&D) carryforwards may be substantially limited due to ownership changes that may have occurred or that could occur in the future, as required by Section 382 of the Internal Revenue Code of 1986, as amended (the Code), as well as similar state provisions.  These ownership changes may limit the amount of NOL, AMT and R&D credit carryforwards that can be utilized annually to offset future taxable income and tax, respectively.  In general, an ownership change, as defined in Section 382 of the Code, results from a transaction or series of transactions over a six-year period resulting in an ownership change of more than 50% of the outstanding stock of a company by certain stockholders or public groups.

We have not completed a study to assess whether one or more ownership changes have occurred since we became a loss corporation as defined in Section 382 of the Code, but we believe that it is likely that an ownership change has occurred.  If we have experienced an ownership change, utilization of the NOL, AMT and R&D credit carryforwards would be subject to an annual limitation, which is determined by first multiplying the value of our common stock at the time of the ownership change by the applicable long-term, tax-exempt rate, and then could be subject to additional adjustments, as required.  Any such limitation may result in the expiration of a portion of the NOL, AMT or R&D credit carryforwards before utilization.  Until a study is completed and any limitation known, no amounts are being considered as an uncertain tax position or disclosed as an unrecognized tax benefit under ASC 740.  Any carryforwards that expire prior to utilization as a result of such limitations will be removed from deferred tax assets with a corresponding adjustment to the valuation allowance.  Due to the existence of the valuation allowance, it is not expected that any potential limitation will have a material impact on our operating results.

From time to time we may be assessed interest or penalties by major tax jurisdictions, namely the states of Massachusetts and California.  As of December 31, 2015, we had no material unrecognized tax benefits and no adjustments to liabilities or operations were required. No interest and penalties have been recognized by the Company to date.

Tax years 2012 through 2015 are subject to examination by the federal and state taxing authorities.  There are no income tax examinations currently in process.

Our net operating loss carryforwards are subject to review and possible adjustment by the Internal Revenue Service and are subject to certain limitations in the event of cumulative changes in the ownership interest of significant stockholders over a three-year period in excess of 50%.

16.

Commitments and Contingencies

On April 1, 2013, we entered into a lease for manufacturing, research and office space in Wilmington, Massachusetts, the lease of which expires on June 30, 2020.  Under the terms of the lease, we are responsible for our proportionate share of real estate taxes and operating expenses relating to this facility.  We leased research and office space in San Diego, California and leased 300 square feet of office space in Shanghai, China.   On March 25, 2015, our Board of Directors approved restructuring actions to better align costs with current and future geographic revenue sources and to improve efficiencies.  In November, 2015, we exited from our lease in San Diego, CA. Total rent expense, including assessments for maintenance and real estate taxes for the six months ended December 31, 2015 and 2014, was $363,000 and $437,000, respectively.



23



IMPLANT SCIENCES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


License Agreements

We are obligated under one license agreement, assumed in connection with the acquisition of Ion Metrics, whereby we were granted rights to use certain intellectual property for safety, security and narcotic applications, which we intend to incorporate into future security product offerings for certain minimum guaranteed annual payments. The license agreement expires on September 30, 2016 and as of December 31, 2015, we have no obligation under this license agreement for future minimum guaranteed payments.

17.

Financial Information By Segment

Operating segments are defined as components of an enterprise about which separate financial information is available that is regularly evaluated by the chief operating decision maker or decision making group, in determining how to allocate resources and in accessing performance. Our chief operating decision making group is composed of the chief executive officer and members of senior management. Based on qualitative and quantitative criteria, we have determined that we operate within one reportable segment, which is the Security Products Segment.

18.

  Legal

On March 23, 2015, Bernard Miller (Mr. Miller), individually and on behalf of all others similarly situated shareholders of the company, filed a complaint against Dr. William J. McGann, Messrs. Glenn D. Bolduc, John H. Hassett, John A. Keating, Robert P. Liscouski, Howard Safir and Michael C. Turmelle and the Company in the Suffolk Superior Court of the Commonwealth of Massachusetts, seeking derivative action as a result of director breaches of fiduciary duty and unjust enrichment.  Amongst other things, the plaintiff requested that the court compel the Company to hold an annual stockholders meeting; subject the September 2012 Amendment to the 2004 Plan to a vote at the next annual stockholders meeting; rescind the stock option awards granted under the September 2012 Amendment to 2004 Plan in the event that the amendment is not approved by a majority of our stockholders; impose a trust, in favor of the Company, for any benefits improperly received; and award costs and expenses, including reasonable attorney fees.

On July 1, 2015 we held our 2015 Annual Meeting of Stockholders. Stockholders approved an amendment to the Companys 2004 Stock Option Plan to increase the aggregate number of shares of the Companys common stock, par value $0.001 per share available for issuance under the Plan by 16,000,000 shares to 20,000,000 shares and approve the Companys Amended and Restated 2014 Stock Option Plan.

On May 22, 2015, a motion to dismiss the Complaint with prejudice was served on the plaintiff and subsequently filed with the Court. On July 21, 2015, the Court endorsed an Order of Stipulation the parties entered into. The Stipulation provides, among other things, that the Complaint is dismissed with prejudice and the Motion to Dismiss is moot. On December 17, 2015, the Court ruled that the Plaintiffs counsel was entitled to a fee of $70,000 together with costs of approximately $6,000. During the three and six months ended December 31, 2015, we recorded a charge of $76,000  in our condensed consolidated statement of operations and comprehensive loss which  is included in current liabilities on our condensed consolidated balance sheets at December 31, 2015.

We are not currently a party to any other legal proceedings, other than routine litigation incidental to our business that which we believe will not have a material effect on our business, assets or results of operations.  From time to time, we are subject to various claims, legal proceedings and investigations covering a wide range of matters that arise in the ordinary course of our business activities.  Each of these matters may be subject to various uncertainties.

19.

Subsequent Events

We have evaluated subsequent events after the balance sheet date through the date these financial statements were issued for appropriate accounting and disclosure and concluded that there are no subsequent events requiring adjustment or disclosure in these financial statements.




24




Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations


Managements discussion and analysis of results of operations and financial condition (MD&A) is a supplement to the accompanying condensed consolidated financial statements and provides additional information on Implant Sciences Corporations (Implant Sciences or the Company) business, current developments, financial condition, cash flows and results of operations.

When we say we, us, our, Company, or Implant Sciences, we mean Implant Sciences Corporation and its subsidiaries.

Please see our Annual Report on Form 10-K for the fiscal year ended June 30, 2015 for a complete description of our business.

Overview

We develop, manufacture and sell sophisticated sensors and systems for the security, safety and defense 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 and narcotics trace detection (ETD and NTD, respectively) applications and market and sell handheld ETD and desktop ETD and NTD systems that use our proprietary 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, other objects and people for the detection of trace amounts of explosives and narcotics.

A significant component of our ability to compete in the markets that we serve are the attainment of regulatory approvals.  We have undertaken considerable efforts in the past twelve to eighteen months in this regard and have achieved the following regulatory approvals and customer orders:

·

Our QS-B220 desktop ETD system successfully completed and passed testing requirements for the TSAs qualification test for aviation checkpoint and checked baggage and has been placed on the TSAs Qualified Product List (QPL) on August 28, 2014. The QS-B220 is the first ETD with a non-radioactive source to be approved by the TSA for use in U.S. airports for passenger and baggage screening. We are now able to participate in TSA tenders for ETD procurements for aviation checkpoint and checked baggage screening.

·

On October 6, 2014, the QS-B220 successfully passed the European Civil Aviation Conference's (ECAC) Common Evaluation Process of Security Equipment (CEP) for airport checkpoint screening of passengers and baggage. The CEP was established to provide standards for security equipment performance across ECAC's 44 member nations.

·

On October 16, 2014, the U.S. Department of Homeland Security (DHS) selected our proposal to develop next generation explosives trace detection screening systems for funding. The project, pending successful negotiations, is potentially worth up to approximately $2 million. Subject to successful conclusion of negotiations with the DHS, we expect the project to commence in the fourth quarter of fiscal 2016.

·

On November 10, 2014, we entered into an Indefinite Delivery / Indefinite Quantity (IDIQ) contract with the United States Transportation Security Administration (TSA) for our QS-B220 desktop explosives trace detectors. The IDIQ, a necessary prerequisite for competing for TSAs annual trace detection procurements and establishes contract terms under which the TSA could purchase up to $162 million of equipment and services.

·

On November 10, 2014, we received an initial delivery order from the TSA for 1,170 QS-B220 desktop explosives trace detectors and commenced shipments under the delivery order in December 2015.  

·

On December 3, 2015, we announced that our Board of Directors has authorized management to retain financial advisors to explore strategic alternatives to maximize shareholder value.



25




Critical Accounting Policies

Our significant accounting policies are summarized in Note 2 to our consolidated financial statements included in Item 7 of our Annual Report on Form 10-K, for the fiscal year ended June 30, 2015. However, certain of our accounting policies require the application of significant judgment by our management, and such judgments are reflected in the amounts reported in our condensed consolidated financial statements. In applying these policies, our management uses judgment to determine the appropriate assumptions to be used in the determination of estimates. Those estimates are based on our historical experience, terms of existing contracts, our observance of market trends, information provided by our strategic partners and information available from other outside sources, as appropriate. Actual results may differ significantly from the estimates contained in our condensed consolidated financial statements.

Results of Operations

Three Months Ended December 31, 2015 vs. December 31, 2014

Revenues



For the Three Months Ended December 31, 2015


For the Three Months Ended December 31, 2014



(In thousands)


Amount


Mix


Amount


Mix


Change

QS-B220


$

7,557


73.4%


$

1,163


54.3%


549.8%

QS-H150


1,725


16.8%


805


37.6%


114.3%

Parts and supplies


1,010


9.8%


173


8.1%


483.8%

Total


$

10,292


100.0%


$

2,141


100.0%


380.7%

Revenues for the three months ended December 31, 2015 were $10,292,000 as compared with $2,141,000 for the comparable prior year period, an increase of $8,151,000, or 380.7%. The increase in revenue is due primarily to a 818.0% increase in the number of QS-B220 desktop units sold in the three months ended December 31, 2015, due to the initial shipments under our delivery order with the U.S. Transportation Security Administration, increased shipments to European airports and increased shipments to Asia, Africa and South America in the current three month period, offset partially by a 29.2% decrease in the average unit sales prices, which resulted in a 549.8% increase in QS-B220 revenues. Factors impacting our average unit sales prices are mainly due to the competitive market conditions and our decision to offer early payment discounts to certain distributors to hasten collection of our accounts receivable, which discounts in the aggregate amounted to $97,000 in the three months ended December 31, 2015.

QS-H150 handheld units sold in the three months ended December 31, 2015, increased 121.4%, compared to the prior period, due to increased shipments to Asia and Africa, which is partially offset by a 3.2% decrease in the average unit sales prices, which resulted in a 114.3% increase in QS-H150 revenues.  

Sales of parts and supplies increased 483.8% in the three months ended December 31, 2015, due primarily to increased sales of consumables and other supplies that shipped with the QS-B220 desktop units in the current three month period.

Sales of QS-B220 were favorably impacted in the comparable prior period due to the acceptance of the QS-B220 into the Qualified section of the TSAs Air Cargo Screening Technology List and achieving European Civil Aviation Conference (ECAC) Common Evaluation Process of Security Equipment for airport checkpoint screening of passengers and baggage. Competitive market conditions are expected to continue to have a negative impact on our average unit sales prices for the foreseeable future.

Cost of Revenues

Cost of revenues for the three months ended December 31, 2015 were $6,439,000 as compared with $1,777,000 for the comparable prior year period, an increase of $4,662,000 or 262.4%. The increase in cost of revenues recorded in the three months ended December 31, 2015 is primarily due to increased unit sales of our QS-B220 desktop units and increased unit sales of our QS-H150 handheld units.




26




Gross Margin

Gross margin for the three months ended December 31, 2015 was $3,853,000 or 37.4% of revenues as compared with $364,000 or 17.0% of revenues for the comparable prior year period. The increase in gross margin as a percent of revenues is primarily due to increased manufacturing overhead absorption, due to increased QS-B220 unit volume and lower material costs for the QS-B220 due to volume purchasing price reductions, partially offset by  a decrease in the average unit sales price on sales of our QS-B220 units of 29.2%. and 3.2% decrease in the average unit sales price on sales of our QS-H150 units.

Research and Development Expense

Research and development expense for the three months ended December 31, 2015 was $901,000 as compared with $1,288,000 for the comparable prior year period, a decrease of $387,000 or 30.0%. The decrease in research and development expense is due primarily to the relocation of the San Diego, CA advanced technology office, which resulted in a $138,000 decrease in payroll and benefit costs, a $73,000 decrease in stock-based compensation, a $91,000 decrease in materials and prototype expense, a $32,000 decrease in rent expense, and a $16,000 decrease in engineering consulting expense. We continue to expend funds to further the development of new products in the areas of explosives and narcotics detection, and to obtain the necessary approvals from the TSA and other non-U.S. government approvals. Spending on research and development will increase in the next six to twelve months due to the ongoing development of the QS-B220 desktop detector, the development of the QS-H150E portable explosives and narcotics detector and continued development of a hyphenated system employing conventional ion mobility, differential mobility and quadrupole mass spectrometry.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three months ended December 31, 2015 were $3,718,000 as compared with $3,195,000 for the comparable prior year period, an increase of $523,000, or 16.4%. The increase in selling, general  and administrative expenses is due primarily a $594,000 increase in consulting expenses due to the issuance of shares of our common stock to two advisors for services rendered under the advisory and consulting services agreements, a $528,000 increase in payroll and related benefits due  primarily to the provision of $480,000 for  incentive compensation, a $298,000 increase in variable selling expenses, due to increased revenues and the $76,000 charge recorded for the plaintiffs counsel fee and expenses, resulting from the Miller litigation,  partially offset by a separation benefits of $725,000 provided to our former CEO due to his resignation in the prior year period, a $112,000 decrease in stock-based compensation on employee stock options, a $52,000 decrease in bad debt expense, and a $33,000 decrease in rent expense.

 Other Expense

For the three months ended December 31, 2015, other expense was $2,547,000 as compared with other expense of $2,125,00, for the comparable prior year period, an increase of $422,000. The increase is due to increased interest expense on higher borrowings under our credit facilities with DMRJ and, to a lesser extent, the 1% increase in the BAM interest rate which took effect on April 1, 2015.

Net Loss

Our net loss for the three months ended December 31, 2015 was $3,313,000 as compared with a net loss of $6,244,000 for the comparable prior year period, a decrease of $2,931,000, or 46.9%. The decrease in the net loss is primarily due to increased revenues and gross margin, partially offset by increased operating expenses and an increase in interest expense.





27




Six Months Ended December 31, 2015 vs. December 31, 2014

Revenues



For the Six Months Ended December 31, 2015


For the Six Months Ended December 31, 2014



(In thousands)


Amount


Mix


Amount


Mix


Change

QS-B220


$

20,048


81.2%


$

1,917


47.8%


945.8%

QS-H150


2,412


9.8%


1,791


44.7%


34.7%

Parts and supplies


2,225


9.0%


302


7.5%


636.8%

Total


$

24,685


100.0%


$

4,010


100.0%


515.6%

Revenues for the six months ended December 31, 2015 were $24,685,000 as compared with $4,010,000 for the comparable prior year period, an increase of $20,675,000, or 515.6%. The increase in revenue is due primarily to a 1,372.6% increase in the number of QS-B220 desktop units sold in the six months ended December 31, 2015, due to increased shipments to European airports, initial shipments under our delivery order with the U.S. Transportation Security Administration, and increased shipments to Asia, Africa and South America in the current six month period, offset partially by a 29.0% decrease in the average unit sales prices, which resulted in a 945.8% increase in QS-B220 revenues. Factors impacting our average unit sales prices are mainly due to the competitive market conditions and our decision to offer early payment discounts to certain distributors to hasten collection of our accounts receivable, which discountsin the aggr amounted to $307,000 in the six months ended December 31, 2015.

QS-H150 handheld units sold in the six months ended December 31, 2015, increased 38.5 %, compared to the prior period, due to increased shipments to Asia and Africa, which is partially offset by a 2.7% decrease in the average unit sales prices, which resulted in a 34.7% increase in QS-H150 revenues.  

Sales of parts and supplies increased 636.8% in the six months ended December 31, 2015, due primarily to increased sales of consumables and other supplies that shipped with the QS-B220 desktop units in the current six month period.

Sales of QS-B220 were favorably impacted in the comparable prior period due to the acceptance of the QS-B220 into the Qualified section of the TSAs Air Cargo Screening Technology List and achieving European Civil Aviation Conference (ECAC) Common Evaluation Process of Security Equipment for airport checkpoint screening of passengers and baggage. Competitive market conditions are expected to continue to have a negative impact on our average unit sales prices for the foreseeable future.

Cost of Revenues

Cost of revenues for the six months ended December 31, 2015 were $14,575,000 as compared with $3,028,000 for the comparable prior year period, an increase of $11,547,000 or 381.3%. The increase in cost of revenues recorded in the six months ended December 31, 2015 is primarily due to increased unit sales of our QS-B220 desktop units and, to a lesser extent, increased unit sales of our QS-H150 handheld units.

Gross Margin

Gross margin for the six months ended December 31, 2015 was $10,110,000 or 41.0% of revenues as compared with $982,000 or 24.5% of revenues for the comparable prior year period. The increase in gross margin as a percent of revenues is primarily due to increased manufacturing overhead absorption, due to increased QS-B220 unit volume and lower material costs for the QS-B220 due to volume purchasing price reductions, partially offset by a 29.0% decrease in the average unit sales price on sales of our QS-B220 units and by a decrease in the average unit sales price on sales of our QS-H150 units of 2.7%.

Research and Development Expense

Research and development expense for the six months ended December 31, 2015 was $1,984,000 as compared with $2,572,000 for the comparable prior year period, a decrease of $588,000 or 22.9%. The decrease in research and development expense is due primarily to the relocation of the San Diego, CA advanced technology office, which resulted in a $251,000 decrease in payroll and benefit costs, a $139,000 decrease in materials and prototype expenses, a $112,000 decrease in stock-based compensation, a $62,000 decrease in regulatory testing expenses, and a $15,000 decrease in rent expense, offset partially by a $43,000 increase in travel expenses incurred in support of the ECAC system deployments in the current period. We continue to expend funds to further the development of new products in the areas of explosives and narcotics detection, and to obtain the necessary



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approvals from the TSA and other non-U.S. government approvals. Spending on research and development will increase in the next six to twelve months due to the ongoing development of the QS-B220 desktop detector, the development of the QS-H150E portable explosives and narcotics detector and continued development of a hyphenated system employing conventional ion mobility, differential mobility and quadrupole mass spectrometry.

 

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the six months ended December 31, 2015 were $7,256,000 as compared with $5,870,000 for the comparable prior year period, an increase of $1,386,000, or 23.6%. The increase in selling, general and administrative expenses is due primarily to a $1,291,000 increase in payroll and benefit costs, due to the provision of $960,000 for  incentive compensation and a $200,000 sign on bonus for Mr. Liscouski, our President, a $858,000 increase in variable selling expenses due to increased revenues, a $588,000 increase in consulting expenses due to the issuance of shares of our common stock to two advisors for services rendered under the advisory and consulting services agreements, a $79,000 increase in travel expense incurred to support QS-B220 system installations in European, the $76,000 charge recorded for the plaintiffs counsel fee and expenses, resulting from the Miller litigation $68,000 increase in legal fees, offset partially by separation benefits of $725,000 provided to our former CEO due to his resignation in the prior year period, a $406,000 decrease in stock-based compensation on employee stock options, a $198,000 decrease in stock-based compensation expense on non-employee warrants, a $53,000 decrease in bad debt expense, and a $46,000 decrease in rent expense.

 Other Expense

For the six months ended December 31, 2015, other expense was $5,094,000 as compared with other expense of $4,159,000, for the comparable prior year period, an increase of $935,000. The increase is due to increased interest expense on higher borrowings under our credit facilities with DMRJ and, to a lesser extent, the 1% increase in the BAM interest rate which took effect on April 1, 2015.

Net Loss

Our net loss for the six months ended December 31, 2015 was $4,224,000 as compared with a net loss of $11,619,000 for the comparable prior year period, a decrease of $7,395,000, or 63.6%. The decrease in the net loss is primarily due to increased revenues and gross margin, partially offset by increased operating expenses and an increase in interest expense.

Liquidity and Capital Resources

As of December 31, 2015 and June 30, 2015, we had cash and cash equivalents of $776,000 and $1,985,000, respectively.

We will be required to repay all of our borrowings from DMRJ, Montsant and from a group of institutional investors for which BAM Administrative Services LLC (BAM) acts as administrative agent, on March 31, 2016. Our obligations to BAM are secured by a security interest in substantially all of our assets. DMRJ and Montsant agreed to subordinate their security interest in all of our assets to the security interest held by BAM (See Note 13).

Our obligations to DMRJ are secured by security interests in substantially all of our assets. As of December 31, 2015, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $12,000,000, $12,000,000, $1,000,000 and $16,862,000, respectively. Further, as of December 31, 2015, our obligation to DMRJ for accrued interest under these instruments approximated $14,559,000 and is included in accrued expenses in the condensed consolidated financial statements.

As of February 5, 2016, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $12,000,000, $12,000,000, $1,000,000 and $16,862,000, respectively. Further, as of February 5, 2016, our obligation to DMRJ for accrued interest under these instruments approximated $15,187,000.

As of December 31, 2015, our obligations to Montsant under a promissory note approximated $3,184,000. Further, as of December 31, 2015, our obligation to Montsant for accrued interest under this instrument approximated $1,860,000 and is included in accrued expenses in the condensed consolidated financial statements.

As of February 5, 2016, our obligations to Montsant under a promissory note approximated $3,184,000. Further, as of February 5, 2016, our obligation to Montsant for accrued interest under this instrument approximated $1,907,000.




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Our obligations to the investors are secured by security interests in substantially all of our assets. As of December 31, 2015, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of December 31, 2015, our obligation under such notes for accrued interest amounted to approximately $1,690,000 and is included in accrued expenses in the condensed consolidated financial statements.

As of February 5, 2016, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of February 5, 2016, our obligation under such notes for accrued interest amounted to approximately $2,010,000.

Each of these notes and the credit facility are described in Note 13 of the Notes to Condensed Consolidated Financial Statements, accompanying this Quarterly Report.

On December 11, 2015, we entered into an Accounts Receivable Purchase Agreement (the Purchase Agreement) with Republic Capital Access, LLC (RCA), pursuant to which we may sell eligible accounts receivables relating to U.S. government prime contracts or subcontracts (as defined in the Purchase Agreement, Eligible Receivables) to RCA.  The total amount of Eligible Receivables that we may sell to RCA is subject to a maximum limit of $2,000,000 of outstanding receivables (the Maximum Amount) at any given time.  The Purchase Agreement terminates on November 30, 2016.

Pursuant to the terms of the Purchase Agreement, we will receive from RCA, within two business days of the submission of the applicable invoice, an initial payment equal to 90% of the face value of an Eligible Receivable purchased by RCA.  Following payment of such Eligible Receivable to RCA by the relevant customer, RCA shall pay the Company the residual 10% of such receivable, less fees payable to RCA by the Company pursuant to the Purchase Agreement. 

We have paid, or will pay, as applicable, the following fees, as applicable, to RCA pursuant to the Purchase Agreement: (i) an initial enrollment fee equal to $5,000.00; (ii) a discount factor equal to 0.35%, for U.S. government contracts (or 0.53% for U.S. government subcontracts), of the amounts of purchased receivables; (iii) a program access fee equal to 0.017% of the daily ending account balance for each day that receivables are outstanding; (iv) a commitment fee equal to 1% of Maximum Amount minus the amount of purchased receivables; and (v) expenses relating to the negotiation of the Purchase Agreement, which amount is not expected to exceed $1,000.  As of December 31, 2015, we had not yet sold any receivables to RCA pursuant to the Purchase Agreement.

BAM Administrative Services LLC and DMRJ Group LLC consented to the transactions contemplated by the Purchase Agreement.

During the six months ended December 31, 2015, we had net cash outflows of $1,373,000 from operating activities as compared to net cash outflows from operating activities of $5,895,000 for the comparable prior year period. The $4,522,000 decrease in net cash outflows used in operating activities during the six months ended December 31, 2015, as compared to the prior year period, was due to the following changes in working capital: (i) a $5,237,000 increase in accounts receivable, compared to a $416,000 increase in the prior period, due to increased product shipments during the latter part of the quarter ended December 31, 2015; (ii) a $1,479,000 increase in inventories compared to a $170,000 decrease in the prior period, due primarily to increased customer order backlog, compared to the prior period; (iii) an increase in accrued expenses of $7,885,000, compared to a $3,125,000 increase in the prior period, due to primarily to an increase in our accrued interest, due to higher borrowings under our credit facilities with DMRJ and the increase in the BAM interest rate, and to a lesser extent, by an increase in accrued expenses in the current period due provisions for incentive compensation recorded in the six months ended December 31, 2015 and an increase in our provision for product warranty costs, due to increased unit shipments of our QS-B220 desktop units; (iv) a $1,854,000 decrease in deferred revenue, compared to a $1,279,000 increase in deferred revenue in the prior year period, due primarily to the application of ECAC customer advance deposits received in the quarter ended June 30, 2015, against accounts receivables resulting from shipments in the six months ended December 31, 2015; and, (v) a $1,942,000 increase in accounts payable, compared to a $134,000 decrease in the prior period, due to increased inventory related payables.

During the six months ended December 31, 2015, we had net cash outflows of $65,000 from investing activities as compared to net cash outflows of $314,000 from investing activities for the prior year period. The $249,000 decrease in net cash used in investing activities during the six months ended December 31, 2015, as compared to the prior year period, was primarily due to increased purchases of equipment in the six months ended December 31, 2014.



30




During the six months ended December 31, 2015 we had net cash inflows of $210,000 from financing activities as compared to net cash inflows of $5,843,000 for the comparable prior year period. The $5,633,000 decrease in net cash from financing activities during the six months ended December 31, 2015, as compared to the prior year period, was primarily due to $200,000 in borrowings under our credit facility with DMRJ, compared to a borrowings of $5,605,000 in the prior fiscal year, and, to a lesser extent, a $227,000 decrease in proceeds received due to the exercise of stock options and warrants.

Credit Facilities with DMRJ Group LLC, Montsant Partners LLC and BAM Administrative Services LLC

In December 2008, we entered into a note and warrant purchase agreement with DMRJ, 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.  Thereafter, we entered into a series of amendments, waivers and modifications of this facility. The notes mature on March 31, 2016.  

On May 4, 2015, we entered into an assignment agreement with DMRJ and Montsant, wherein DMRJ assigned its rights, title and interest in the senior secured promissory note dated December 10, 2008 and appointed DMRJ as its collateral agent under the promissory note agreement. The note matures on March 31, 2016. DMRJ and Montsant are funds managed by Platinum Partners Value Arbitrage Fund LP.

In March, 2014, we entered into a note purchase agreement with a group of institutional investors and BAM, an administrative agent for the investors, pursuant to which we issued senior secured promissory notes in the aggregate principal amount of $20,000,000. The notes bear interest at 16% per annum and mature on March 31, 2016.  We used all of the proceeds from the sale of the notes to repay (i) $17,624,000 of our outstanding indebtedness to DMRJ under revolving promissory note (ii) $1,809,000 of interest outstanding under that facility and (iii) $567,000 of interest outstanding under our senior secured convertible promissory note.

See Note 13 of Notes to Condensed Consolidated Financial Statements, accompanying this Quarterly Report. There can be no assurance that we will be successful in refinancing or extending our obligations to our secured lenders.  

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 that we 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.  Further, upon the occurrence of an event of default under certain provisions of our credit agreements, we could be required to pay default rate interest equal to the lesser of 2.5% per month and the maximum applicable legal rate per annum on the outstanding principal balance outstanding. The failure to refinance or otherwise negotiate further extensions of our obligations to our secured lenders 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.

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, provided that our credit facilities are extended. These plans depend on a substantial increase in sales of our handheld trace explosives detector product and our desktop explosives and narcotics trade detector product and on the extension of the maturity date of our credit facilities with DMRJ, BAM and Montsant.  However, there can be no assurances that sales will materialize as forecasted, and/or that management will be successful in refinancing or extending our obligations to our secured lenders, which mature on March 31, 2016. 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. 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.

Despite our current sales, expense and cash flow projections and $3,084,000 in cash available from our line of credit with DMRJ, at February 5, 2016, to fund our operations and continue the development, commercialization and marketing of our products will require that we extend our credit facilities with DMRJ, BAM and Montsant. There can be no assurance that DMRJ will continue to make advances under our revolving line of credit. 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. These conditions raise substantial doubt as to our ability to continue as a going concern.



31




Off-Balance Sheet Arrangements

As of December 31, 2015, we had one irrevocable standby letter of credit outstanding in the approximate amount of $297,000. The letter of credit provides warranty performance security equal to 5% of the contract amount with the India Ministry of Defence. We have amended the letter of credit, extending the expiration date to May 28, 2016.

As of December 31, 2015, 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.

Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. The FASB issued ASU 2014-09 to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards. The core principle of this updated guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new rule also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This guidance is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods therein, which is effective for our fiscal year beginning July 1, 2018, the first day of our 2019 fiscal year. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

In June 2014, the FASB issued Accounting Standards Update 2014-12, Compensation-Stock Compensation (ASU 2014-12). The FASB issued ASU 2014-12 to provide specific guidance on share-based payment awards that provide for achievement of a specific performance target that could be achieved after the requisite service period. ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period should be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. This guidance is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, which is effective for our fiscal year beginning July 1, 2016, the first day of our 2017 fiscal year. Earlier adoption is permitted. ASU 2014-12 may be applied prospectively to all awards granted or modified after the effective date or retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. If retrospective transition is adopted, the cumulative effect of applying this guidance should be recognized in the financial statements as an adjustment to the opening retained earnings balance at that date. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

In August 2014, the FASB issued Accounting Standards Update 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40) (ASU 2014-15). ASU 2014-15 provides guidance to U.S. GAAP about managements responsibility to evaluate whether there is a substantial doubt about an entitys ability to continue as a going concern and to provide related footnote disclosures. This new rule requires management to assess an entitys ability to continue as a going concern by incorporating and expanding upon certain principles currently in U.S. auditing standards. Specifically, ASU 2014-15 (1) defines the term substantial doubt, (2) requires an evaluation of every reporting period including interim periods, (3) provides principles for considering the mitigating effect of managements plan, (4) requires certain disclosures when substantial doubt is alleviated as a result of consideration of managements plans, (5) requires an express statement and other disclosures when substantial doubt is not alleviated, and (6) requires an assessment for a period of one year after the date that the financial statements are issued. This guidance is effective for annual periods ending after December 15, 2016, which is effective for our fiscal year beginning July 1, 2016, the first day of our 2017 fiscal year. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

In July 2015, the FASB issued Accounting Standards Update 2015-11, Inventory (Topic 330) (ASU 2015-11). ASU 2015-11 was issued to more closely align the measurement of inventory in U.S. GAAP with the measurement of inventory in International Financial Reporting Standards. The core principle of this updated guidance is that an entity should 

32



measure inventory at the lower of cost or net realizable value.  Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments in ASU 2015-11 apply to inventory that is measured using the first-in, first-out or average cost methods. ASU 2015-11 amends some of the guidance in Topic 330 to more clearly articulate the requirements for the measurement and disclosure of inventory, but the clarifications are not intended to result in any changes in practice other than the change in the subsequent measurement guidance from the lower of cost or market to the lower of cost or net realizable value for inventory.  There are no other substantive changes to the guidance on the measurement of inventory. This guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, which is effective for our fiscal year beginning July 1, 2017, the first day of our 2018 fiscal year. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

 

In August 2015, the FASB issued Accounting Standards Update 2015-15, Interest Imputation of Interest (Subtopic 835-30) Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements (ASU 2015-15). ASU 2015-15 states that Staff at the Securities and Exchange Commission would not object to an entity deferring or presenting debt issuance costs as an asset and subsequently amortizing deferred debt issuance cost ratably over the term of the line-of-credit arrangement, regardless of whether there were outstanding borrowings under the arrangement. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains certain statements that are forward-looking within the meaning of the federal securities laws. 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.

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 Report. Important factors that could cause actual results to differ from our predictions include those discussed under this Managements Discussion and Analysis and under Risk Factors, as well as those discussed under Risk Factors, Managements Discussion and Analysis and Business in our Annual Report on Form 10-K for the fiscal year ended June 30, 2015. 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 Quarterly Report, in our Annual Report on Form 10-K for the fiscal year ended June 30, 2015 and in the other documents that we file with the Securities and Exchange Commission. You can read these documents at www.sec.gov.








33




Item 4.

Controls and Procedures

The certifications of our Chief Executive Officer and Chief Financial Officer attached as Exhibits 31.1 and 31.2 to this Quarterly Report on Form 10-Q 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 4 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 December 31, 2015.  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 companys 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.

As a result of material weaknesses described in our Annual Report on Form 10-K for the year ended June 30, 2015, our Chief Executive Officer and Chief Financial Officer concluded that, we did not maintain effective internal control over financial reporting as of December 31, 2015 and further concluded that, as of such date, our disclosure controls and procedures were not effective at the reasonable assurance level.

Remediation

We are committed to remediating the material weaknesses identified in internal controls over financial reporting and have begun the process to remediate these material weaknesses, however the timing of completing our remediation efforts is uncertain. Our efforts will focus on instituting mitigating controls to address segregation of duties and undertake a thorough review of the finance functions position responsibilities and the hiring of additional staff; implement additional controls to address system access deficiencies; establish independent review and verification procedures for our vendor and customer master files; enhance the documentation to support review occurrences and approval procedures; and, commence regular periodic reviews of our internal controls over financial reporting with our Board of Directors and Audit Committee to address the inadequate risk oversight function and institute procedures to evaluate and report on risks to financial reporting, including the documentation and completion of a comprehensive risk assessment to identify all potential risk areas and evaluate the adequacy of our controls to mitigate these risks.  

Changes in Internal Control Over Financial Reporting

During the three months ended December 31, 2015, we have implemented additional controls to address system access deficiencies and have begun instituting mitigating controls to address segregation of duty issues. There are no other changes that have materially affected, or is reasonably likely to materially affect our internal controls over financial reporting.










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PART II.

OTHER INFORMATION

Item 1.

Legal Proceedings

On March 23, 2015, Bernard Miller (Mr. Miller), individually and on behalf of all others similarly situated shareholders of the company, filed a complaint against Dr. William J. McGann, Messrs. Glenn D. Bolduc, John H. Hassett, John A. Keating, Robert P. Liscouski, Howard Safir and Michael C. Turmelle and the Company in the Suffolk Superior Court of the Commonwealth of Massachusetts, seeking derivative action as a result of director breaches of fiduciary duty and unjust enrichment.  Amongst other things, the plaintiff requested that the court compel the Company to hold an annual stockholders meeting; subject the September 2012 Amendment to the 2004 Plan to a vote at the next annual stockholders meeting; rescind the stock option awards granted under the September 2012 Amendment to 2004 Plan in the event that the amendment is not approved by a majority of our stockholders; impose a trust, in favor of the Company, for any benefits improperly received; and award costs and expenses, including reasonable attorney fees.

On July 1, 2015 we held our 2015 Annual Meeting of Stockholders. Stockholders approved an amendment to the Companys 2004 Stock Option Plan to increase the aggregate number of shares of the Companys common stock, par value $0.001 per share available for issuance under the Plan by 16,000,000 shares to 20,000,000 shares and approve the Companys Amended and Restated 2014 Stock Option Plan.

On May 22, 2015, a motion to dismiss the Complaint with prejudice was served on the plaintiff and subsequently filed with the Court. On July 21, 2015, the Court endorsed an Order of Stipulation the parties entered into. The Stipulation provides, among other things, that the Complaint is dismissed with prejudice and the Motion to Dismiss is moot. On December 17, 2015, the Court ruled that the Plaintiffs counsel was entitled to a fee of $70,000 together with costs of approximately $6,000. During the three and six months ended December 31, 2015, we recorded a charge of $76,000  in our condensed consolidated statement of operations and comprehensive loss which  is included in current liabilities on our condensed consolidated balance sheets at December 31, 2015.

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 effect on our business, assets or results of operations.

Item 1A.

Risk Factors

Other than as set forth below, there have not been any material changes from the risk factors previously disclosed under Item 1A of our Annual Report on Form 10-K, for the fiscal year ended June 30, 2015.

We will be required to repay our secured borrowings on March 31, 2016.

We will be required to repay all of our borrowings from DMRJ, Montsant and from a group of institutional investors for which BAM Administrative Services LLC (BAM) acts as administrative agent, on March 31, 2016. Our obligations to BAM are secured by a security interest in substantially all of our assets. DMRJ and Montsant agreed to subordinate their security interest in all of our assets to the security interest held by BAM (See Note 13).

Our obligations to DMRJ are secured by security interests in substantially all of our assets. As of December 31, 2015, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $12,000,000, $12,000,000, $1,000,000 and $16,862,000, respectively. Further, as of December 31, 2015, our obligation to DMRJ for accrued interest under these instruments approximated $14,559,000 and is included in accrued expenses in the condensed consolidated financial statements.

As of February 5, 2016, our obligations to DMRJ under each of the six promissory notes and a revolving line of credit approximated $12,000,000, $12,000,000, $1,000,000 and $16,862,000, respectively. Further, as of February 5, 2016, our obligation to DMRJ for accrued interest under these instruments approximated $15,187,000.

As of December 31, 2015, our obligations to Montsant under a promissory note approximated $3,184,000. Further, as of December 31, 2015, our obligation to Montsant for accrued interest under this instrument approximated $1,860,000 and is included in accrued expenses in the condensed consolidated financial statements.

As of February 5, 2016, our obligations to Montsant under a promissory note approximated $3,184,000. Further, as of February 5, 2016, our obligation to Montsant for accrued interest under this instrument approximated $1,907,000.




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Our obligations to the investors are secured by security interests in substantially all of our assets. As of December 31, 2015, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of December 31, 2015, our obligation under such notes for accrued interest amounted to approximately $1,690,000 and is included in accrued expenses in the condensed consolidated financial statements.

As of February 5, 2016, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of February 5, 2016, our obligation under such notes for accrued interest amounted to approximately $2,010,000.

If we are unable to repay these amounts as required, refinance our obligations to DMRJ, BAM and Montsant or negotiate extensions of these obligations, DMRJ, BAM and Montsant may seize our assets and we may be forced to file for protection under bankruptcy laws and to curtail or discontinue operations entirely.

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 operating expenses and plans to increase sales and increase cash flow from operations. Despite our current sales, expense and cash flow projections and $3,084,000 in cash available from our line of credit with DMRJ, at February 5, 2016, to fund our operations and continue the development, commercialization and marketing of our products will require that we extend our credit facilities with DMRJ, BAM and Montsant. There can be no assurance that DMRJ will continue to make advances under our revolving line of credit. 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. These conditions raise substantial doubt as to our ability to continue as a going concern.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

During the three months ended December 31, 2015, we issued 330,000 shares of common stock, having a value of approximately $248,000, to two advisors, in consideration of services rendered to us under two advisory and consulting services agreements. The issuance of these shares was exempt from registration under the Securities Act pursuant to an exemption provided by Section 4(2) of the Securities Act.




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Item 6.

Exhibits

Exhibit No.


Description


10.1


Accounts Receivable Purchase Agreement, dated as of December 11, 2015, between Implant Sciences Corporation and Republic Capital Access, LLC (incorporated herein by reference Exhibit 10.1 to Implant Sciences Corporations Current Report on Form 8-K dated December 22, 2015 and filed  on January 4, 2016).

10.2


Lien Release Agreement, dated as of December 17, 2015, between Republic Capital Access, LLC and DMRJ Group, LLC (incorporated herein by reference to Exhibit 10.2 to Implant Sciences Corporations Current Report on Form 8-K dated December 22, 2015and filed on January 4, 2016).


10.3


Lien Release and Amendment Agreement, dated as of December 22, 2015, between Republic Capital Access, LLC, BAM Administrative Services, LLC and Implant Sciences Corporation (incorporated herein by reference to Exhibit 10.3 to Implant Sciences Corporations Current Report on Form 8-K dated December 22, 2015 and filed on January 4, 2016).


10.4


Amendment No. 1 to Employment Agreement between Implant Sciences Corporation and William McGann, dated January 6, 2016.*

10.5


Amendment No. 1 to Employment Agreement between Implant Sciences Corporation and Darryl Jones, dated January 6, 2016.*

10.6


Amendment No. 1 to Employment Agreement between Implant Sciences Corporation and   Todd Silvestri, dated January 6, 2016.*

10.7


Amendment No. 1 to Employment Agreement between Implant Sciences Corporation and Brenda Baron, dated January 6, 2016.*

10.8


Amendment No. 1 to Employment Agreement between Implant Sciences Corporation and Roger Deschenes, dated January 6, 2016.*

10.9


Employment Agreement between Implant Sciences Corporation and Robert Liscouski, dated December 15, 2015.*

31.1


Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2


Certification of 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.**

101.INS


XBRL Instance Document.

101.SCH


XBRL Taxonomy Extension Schema Document.

101.CAL


XBRL Taxomony Extension Calculation Linkbase Document.

101.LAB


XBRL Taxonomy Extension Label Linkbase Document.

101.PRE


XBRL Taxonomy Extension Presentation Linkbase Document.

101.DEF


XBRL Taxonomy Extension Definition Linkbase Document.


*

Indicates a management contract of compensatory plan or arrangement.

**

In accordance with Item 601(b)(32)(ii) of Regulation S-K, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed to be filed for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filings under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.





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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



Implant Sciences Corporation


By:

/s/ William J. McGann



William J. McGann

Chief Executive Officer

(Principal Executive Officer)





By:

/s/ Roger P. Deschenes



Roger P. Deschenes

Vice President, Finance and Chief Financial Officer

(Principal Financial Officer and Chief Accounting Officer)




Dated: February 16, 2016






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