##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549-1004

FORM 10-Q

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

For the Quarter Ended September 30, 2003
Commission File Number 1-10515

JMAR TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)


|                                |  |                       
|------------------------------- |  | ----------------------
|Delaware                        |  | 68-0131180            
|                                |  |                       
|(State or other jurisdiction of |  | (I.R.S. employer      
|incorporation or organization)  |  | identification number)

5800 Armada Drive
Carlsbad, CA 92008
(760) 602-3292




(Address, including zip code and telephone number including
area code of registrants principal executive office)


Indicate by check mark whether the registrant 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, and has been subject to the filing requirements for at
least the past 90 days.

|      |  |     
|----- |  | ----
|Yes x |  | No o

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).

|      |  |     
|----- |  | ----
|Yes o |  | No x

Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date (November 6, 2003).

Common Stock, $.01 par value: 26,910,550 shares





---

TABLE OF CONTENTS



|                               |                                                                                               |                                               |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- | --------------------------------------------- |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION
|                               |                                                                                               | CONSOLIDATED BALANCE SHEETS                  
|                               |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS        
|                               |                                                                                               | CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
|                               |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS        
|                               |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                               | Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                               | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                               | Item 4. Controls and Procedures                                                              
|PART II  OTHER INFORMATION   
|                               | Item 1. Legal Proceedings                                                                    
|                               | Item 2. Changes in Securities                                                                
|                               | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURE                     
|EXHIBIT 31.1                  
|EXHIBIT 31.2                  
|EXHIBIT 32.1                  



---



##### Table of Contents



INDEX

|         |  |                                                                                                                                                              |  |       
|-------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------
|         |  |                                                                                                                                                              |  | Page #
|         |  |                                                                                                                                                              |  |       
|PART I.  |  | FINANCIAL INFORMATION                                                                                                                                        |  |       
|Item 1.  |  | Financial Statements                                                                                                                                         |  |       
|         |  | Consolidated Balance Sheets  September 30, 2003 (unaudited) and December 31, 2002                                                                           |  | 2     
|         |  | Consolidated Statements of Operations (unaudited)  Three months ended September 30,
2003 and 2002 and nine months ended September 30, 2003 and 2002         |  | 3     
|         |  | Consolidated Statements of Comprehensive Loss (unaudited)  Three months ended
September 30, 2003 and 2002 and nine months ended September 30, 2003 and 2002 |  | 4     
|         |  | Consolidated Statements of Cash Flows (unaudited)  Nine months ended September 30,
2003 and 2002                                                            |  | 5     
|         |  | Notes to Consolidated Financial Statements (unaudited)                                                                                                       |  | 6     
|Item 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                                        |  | 16    
|Item 3.  |  | Quantitative and Qualitative Disclosures About Market Risk                                                                                                   |  | 27    
|Item 4.  |  | Controls and Procedures                                                                                                                                      |  | 27    
|PART II. |  | OTHER INFORMATION                                                                                                                                            |  |       
|Item 1.  |  | Legal Proceedings                                                                                                                                            |  | 27    
|Item 2.  |  | Changes in Securities                                                                                                                                        |  | 28    
|Item 3.  |  | N/A                                                                                                                                                          |  |       
|Item 4.  |  | N/A                                                                                                                                                          |  |       
|Item 5.  |  | N/A                                                                                                                                                          |  |       
|Item 6.  |  | Exhibits and Reports on Form 8-K                                                                                                                             |  | 28    

| 
|-
|1





---



##### Table of Contents









PART I - FINANCIAL INFORMATION

JMAR TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
As of September 30, 2003 and December 31, 2002

|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |              |            |  |  | 
|------------------------------------------------------------------------------------------------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------------------------------------ | ----------- | ---------- | ------------- | --------- | ------------ | ---------- |  |  | 
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            | September 30, |           | December 31,
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            | 2003          |           | 2002        
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            | (Unaudited)   |           |              |            | 
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      | ASSETS      |            |               |           |              |            |  |  | 
|Current Assets:                                                                                        |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|                                                                                                       | Cash and cash equivalents                                                                                                                                                                                                                      |                                            | $                                    | 2,193,778   |            |               | $         | 2,246,264    |           
|                                                                                                       | Restricted cash                                                                                                                                                                                                                                |                                            |                                      | 189,704     |            |               |           | 1,550,000    |           
|                                                                                                       | Accounts receivable, net                                                                                                                                                                                                                       |                                            |                                      | 2,723,956   |            |               |           | 2,894,393    |           
|                                                                                                       | Inventories                                                                                                                                                                                                                                    |                                            |                                      | 346,124     |            |               |           | 389,467      |           
|                                                                                                       | Current assets held for sale                                                                                                                                                                                                                   |                                            |                                      | 129,819     |            |               |           | 1,349,758    |           
|                                                                                                       | Prepaid expenses and other                                                                                                                                                                                                                     |                                            |                                      | 758,421     |            |               |           | 524,863      |           
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|                                                                                                       |                                                                                                                                                                                                                                                | Total current assets                       |                                      |             | 6,341,802  |               |           |              | 8,954,745  | 
|Property and equipment, net                                                                            |                                                                                                                                                                                                                                                |                                            | 868,777                              |             |            |               | 1,248,198 |             
|Intangible assets, net                                                                                 |                                                                                                                                                                                                                                                |                                            | 667,716                              |             |            |               | 930,056   |             
|Other assets                                                                                           |                                                                                                                                                                                                                                                |                                            | 342,699                              |             |            |               | 197,754   |             
|Goodwill, net                                                                                          |                                                                                                                                                                                                                                                |                                            | 3,790,907                            |             |            |               | 3,790,907 |             
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|                                                                                                       |                                                                                                                                                                                                                                                | TOTAL ASSETS                               |                                      | $           | 12,011,901 |               |           | $            | 15,121,660 | 
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|                                                                                                       |                                                                                                                                                                                                                                                |                                            | LIABILITIES AND STOCKHOLDERS EQUITY |             |            |               |           |              |            |  | 
|Current Liabilities:                                                                                   |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|                                                                                                       | Accounts payable                                                                                                                                                                                                                               |                                            | $                                    | 1,934,359   |            |               | $         | 1,864,405    |           
|                                                                                                       | Accrued liabilities                                                                                                                                                                                                                            |                                            |                                      | 635,836     |            |               |           | 1,558,307    |           
|                                                                                                       | Accrued payroll and related costs                                                                                                                                                                                                              |                                            |                                      | 580,493     |            |               |           | 797,987      |           
|                                                                                                       | Customer deposits                                                                                                                                                                                                                              |                                            |                                      | 76,804      |            |               |           | 832,607      |           
|                                                                                                       | Line of credit and notes payable, net of discount                                                                                                                                                                                              |                                            |                                      | 1,212,410   |            |               |           | 1,556,405    |           
|                                                                                                       | Current liabilities of assets held for sale, including notes payable                                                                                                                                                                           |                                            |                                      | 1,728,327   |            |               |           | 3,125,151    |           
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|                                                                                                       |                                                                                                                                                                                                                                                | Total current liabilities                  |                                      |             | 6,168,229  |               |           |              | 9,734,862  | 
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|Notes payable and other long-term liabilities, net of current portion                                  |                                                                                                                                                                                                                                                |                                            | 516,901                              |             |            |               | 1,708,804 |             
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|Redeemable convertible preferred stock, 202,820 shares issued and
outstanding as of September 30, 2003 |                                                                                                                                                                                                                                                |                                            | 1,451,237                            |             |            |               |          |             
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|Stockholders equity:                                                                                  |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|                                                                                                       | Preferred stock, $.01 par value; 5,000,000 shares authorized; 202,820
shares issued and outstanding as of September 30, 2003 included in
redeemable convertible preferred stock above, and none issued and
outstanding as of December 31, 2002 |                                            |                                      |            |            |               |           |             |           
|                                                                                                       | Common stock, $.01 par value; 40,000,000 shares authorized;
Issued and outstanding 26,610,550 shares as of September 30, 2003 and
23,852,024 shares as of December 31, 2002                                                                    |                                            |                                      | 266,106     |            |               |           | 238,520      |           
|                                                                                                       | Additional-paid in capital                                                                                                                                                                                                                     |                                            |                                      | 60,343,690  |            |               |           | 56,636,991   |           
|                                                                                                       | Accumulated deficit                                                                                                                                                                                                                            |                                            |                                      | (56,734,262 | )          |               |           | (53,197,517  | )         
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|                                                                                                       |                                                                                                                                                                                                                                                | Total stockholders equity                 |                                      |             | 3,875,534  |               |           |              | 3,677,994  | 
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             
|                                                                                                       |                                                                                                                                                                                                                                                | TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |                                      | $           | 12,011,901 |               |           | $            | 15,121,660 | 
|                                                                                                       |                                                                                                                                                                                                                                                |                                            |                                      |             |            |               |           |             



| |  | The accompanying notes to these consolidated financial statements are an
integral part of these consolidated balance sheets.
| |  | ----------------------------------------------------------------------------------------------------------------------------

2



---



##### Table of Contents






JMAR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended September 30, 2003 and 2002
and Nine Months Ended September 30, 2003 and 2002
(Unaudited)

|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |           |            |           | 
|--------------------------------------------------------------- | ------------------------------------------- | ----------------------------------------------- | ------------ | --------- | ------------------ | ------- | ----------------- | --------- | ------------- | --------- | ------------- | --------- | ---------- | --------- | ---------- | --------- | ---------- | --------- | 
|                                                                |                                             |                                                 |              |           | Three Months Ended |         | Nine Months Ended
|                                                                |                                             |                                                 |              |           |                    |         |                  
|                                                                |                                             |                                                 |              |           | September 30,      |         | September 30,     |           | September 30, |           | September 30,
|                                                                |                                             |                                                 |              |           | 2003               |         | 2002              |           | 2003          |           | 2002         
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |              
|Sales                                                           |                                             | $                                               | 3,964,930    |           |                    | $       | 6,462,633         |           |               | $         | 13,726,298    |           |            | $         | 14,656,910 |          
|Costs of sales                                                  |                                             |                                                 | 2,981,708    |           |                    |         | 5,312,829         |           |               |           | 10,860,273    |           |            |           | 10,992,207 |          
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|                                                                |                                             |                                                 | Gross profit |           |                    | 983,222 |                   |           |               | 1,149,804 |               |           |            | 2,866,025 |            |           |            | 3,664,703 | 
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|Operating expenses:                                             |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|                                                                | Selling, general and administrative         |                                                 |              | 1,116,762 |                    |         |                   | 1,343,624 |               |           |               | 3,499,933 |            |           |            | 3,711,490 |           
|                                                                | Asset writedown and special item            |                                                 |              |          |                    |         |                   | 1,074,324 |               |           |               | 200,056   |            |           |            | 1,074,324 |           
|                                                                | Research and development                    |                                                 |              | 176,100   |                    |         |                   | 203,138   |               |           |               | 397,932   |            |           |            | 586,270   |           
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|                                                                | Total operating expenses                    |                                                 |              | 1,292,862 |                    |         |                   | 2,621,086 |               |           |               | 4,097,921 |            |           |            | 5,372,084 |           
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|Loss from operations                                            |                                             |                                                 | (309,640     | )         |                    |         | (1,471,282        | )         |               |           | (1,231,896    | )         |            |           | (1,707,381 | )        
|Realized gain on sale of marketable securities                  |                                             |                                                 |             |           |                    |         |                  |           |               |           |              |           |            |           | 1,349,721  |          
|Interest and other income                                       |                                             |                                                 | 3,801        |           |                    |         | 2,565             |           |               |           | 59,859        |           |            |           | 29,654     |          
|Interest and other expense                                      |                                             |                                                 | (264,649     | )         |                    |         | (46,640           | )         |               |           | (495,475      | )         |            |           | (153,061   | )        
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|Loss from continuing operations before income taxes             |                                             |                                                 | (570,488     | )         |                    |         | (1,515,357        | )         |               |           | (1,667,512    | )         |            |           | (481,067   | )        
|Income tax expense                                              |                                             |                                                 |             |           |                    |         |                  |           |               |           |              |           |            |           | (484,423   | )        
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|Loss from continuing operations                                 |                                             |                                                 | (570,488     | )         |                    |         | (1,515,357        | )         |               |           | (1,667,512    | )         |            |           | (965,490   | )        
|Discontinued operations:                                        |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|                                                                |                                             | Loss from operations of discontinued operations |              |           | (258,673           | )       |                   |           | (1,321,299    | )         |               |           | (1,405,490 | )         |            |           | (3,620,952 | )        
|                                                                |                                             | Gain on disposal of discontinued operations     |              |           | 205,000            |         |                   |           |              |           |               |           | 205,000    |           |            |           |           |          
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|Net loss                                                        |                                             |                                                 | (624,161     | )         |                    |         | (2,836,656        | )         |               |           | (2,868,002    | )         |            |           | (4,586,442 | )        
|Preferred stock dividends                                       |                                             |                                                 | (439,290     | )         |                    |         |                  |           |               |           | (668,743      | )         |            |           |           |          
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|Loss applicable to common stock                                 |                                             | $                                               | (1,063,451   | )         |                    | $       | (2,836,656        | )         |               | $         | (3,536,745    | )         |            | $         | (4,586,442 | )        
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|Basic and diluted loss per share:                               |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|                                                                | Loss per share from continuing operations   |                                                 | $            | (0.04     | )                  |         | $                 | (0.06     | )             |           | $             | (0.09     | )          |           | $          | (0.04     | )         
|                                                                | Loss per share from discontinued
operations |                                                 |              |          |                    |         |                   | (0.06     | )             |           |               | (0.05     | )          |           |            | (0.16     | )         
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|Basic and diluted loss per share applicable to
common stock     |                                             | $                                               | (0.04        | )         |                    | $       | (0.12             | )         |               | $         | (0.14         | )         |            | $         | (0.20      | )        
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|Shares used in computation of basic and
diluted loss per share: |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|                                                                |                                             | Basic                                           |              |           | 25,500,260         |         |                   |           | 23,844,685    |           |               |           | 24,550,380 |           |            |           | 23,360,208 |          
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          
|                                                                |                                             | Diluted                                         |              |           | 25,500,260         |         |                   |           | 23,844,685    |           |               |           | 24,550,380 |           |            |           | 23,360,208 |          
|                                                                |                                             |                                                 |              |           |                    |         |                   |           |               |           |               |           |            |           |            |          

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

3



---



##### Table of Contents






JMAR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
For the Three Months Ended September 30, 2003 and 2002
and Nine Months Ended September 30, 2003 and 2002
(Unaudited)

|                          |                                                            |   |                    |   |                   |   |               |   |               |   |            |   |  |   |            |            |  
|------------------------- | ---------------------------------------------------------- | - | ------------------ | - | ----------------- | - | ------------- | - | ------------- | - | ---------- | - |  | - | ---------- | ---------- | -
|                          |                                                            |   | Three Months Ended |   | Nine Months Ended
|                          |                                                            |   |                    |   |                  
|                          |                                                            |   | September 30,      |   | September 30,     |   | September 30, |   | September 30,
|                          |                                                            |   | 2003               |   | 2002              |   | 2003          |   | 2002         
|                          |                                                            |   |                    |   |                   |   |               |   |              
|Net loss                  |                                                            | $ | (624,161           | ) |                   | $ | (2,836,656    | ) |               | $ | (2,868,002 | ) |  | $ | (4,586,442 | )         
|                          |                                                            |   |                    |   |                   |   |               |   |               |   |            |   |  |   |            |           
|Other comprehensive loss: |                                                            |   |                    |   |                   |   |               |   |               |   |            |   |  |   |            |           
|                          | Holding loss on marketable securities                      |   |                    |  |                   |   |               |  |               |   |            |  |  |   |            | (75,143    | )
|                          | Reclassification adjustment for
gains included in net loss |   |                    |  |                   |   |               |  |               |   |            |  |  |   |            | (1,349,721 | )
|                          |                                                            |   |                    |   |                   |   |               |   |               |   |            |   |  |   |            |           
|                          | Other comprehensive loss                                   |   |                    |  |                   |   |               |  |               |   |            |  |  |   |            | (1,424,864 | )
|                          |                                                            |   |                    |   |                   |   |               |   |               |   |            |   |  |   |            |           
|Comprehensive loss        |                                                            | $ | (624,161           | ) |                   | $ | (2,836,656    | ) |               | $ | (2,868,002 | ) |  | $ | (6,011,306 | )         
|                          |                                                            |   |                    |   |                   |   |               |   |               |   |            |   |  |   |            |           



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

4



---



##### Table of Contents






JMAR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2003 and 2002
(Unaudited)

|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |            |            |          |  
|---------------------------------------------- | --------------------------------------------------------------------------------------------------- | ---------------------------------------------- | ---------------------------------------- | ---------- | ------------------ | ---------- | ------------------ | ---------- | ---------- | -------- | -
|                                               |                                                                                                     |                                                |                                          |            | September
30, 2003 |            | September
30, 2002
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                   
|Cash flows from operating activities:          |                                                                                                     |                                                |                                          |            |                    |            |                    |           
|                                               | Loss from continuing operations                                                                     |                                                | $                                        | (1,667,512 | )                  |            | $                  | (965,490   | )         
|                                               | Adjustments to reconcile loss from continuing operations to net
cash used in continuing operations: |                                                |                                          |            |                    |            |                    |            |           
|                                               |                                                                                                     | Depreciation, amortization and debt discount   |                                          |            | 683,554            |            |                    |            | 465,264    |         
|                                               |                                                                                                     | Services received in exchange for common stock |                                          |            | 7,200              |            |                    |            | 5,999      |         
|                                               |                                                                                                     | Gain on sale of marketable securities          |                                          |            |                   |            |                    |            | (1,349,721 | )       
|                                               |                                                                                                     | Asset writedown and special item               |                                          |            | 200,056            |            |                    |            | 512,807    |         
|                                               |                                                                                                     | Change in assets and liabilities:              |                                          |            |                    |            |                    |            |            |         
|                                               |                                                                                                     |                                                | Accounts receivable, net                 |            |                    | 170,437    |                    |            |            | 72,671   |  
|                                               |                                                                                                     |                                                | Inventories                              |            |                    | 43,343     |                    |            |            | (40,577  | )
|                                               |                                                                                                     |                                                | Prepaid expenses and other               |            |                    | (131,960   | )                  |            |            | 20,550   |  
|                                               |                                                                                                     |                                                | Customer deposits                        |            |                    | (755,803   | )                  |            |            | (625,673 | )
|                                               |                                                                                                     |                                                | Accounts payable and accrued liabilities |            |                    | (1,057,999 | )                  |            |            | 511,721  |  
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |           
|                                               | Net cash used in continuing operations operating activities                                         |                                                |                                          | (2,508,684 | )                  |            |                    | (1,392,449 | )         
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |           
|                                               | Loss from discontinued operations                                                                   |                                                |                                          | (1,200,490 | )                  |            |                    | (3,620,952 | )         
|                                               | Changes in net assets and liabilities of discontinued operations                                    |                                                |                                          | (243,077   | )                  |            |                    | 778,860    |           
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |           
|                                               | Net cash used in discontinued operations                                                            |                                                |                                          | (1,443,567 | )                  |            |                    | (2,842,092 | )         
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |           
|                                               | Net cash used in operating activities                                                               |                                                |                                          | (3,952,251 | )                  |            |                    | (4,234,541 | )         
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |           
|Cash flows from investing activities:          |                                                                                                     |                                                |                                          |            |                    |            |                    |           
|                                               | Proceeds from sale of marketable securities                                                         |                                                |                                          |           |                    |            |                    | 1,399,746  |           
|                                               | Capital expenditures                                                                                |                                                |                                          | (57,064    | )                  |            |                    | (289,209   | )         
|                                               | Intangible assets, other assets and goodwill                                                        |                                                |                                          | (193,621   | )                  |            |                    | 396,135    |           
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |            |           
|                                               | Net cash provided by (used in) investing activities                                                 |                                                |                                          | (250,685   | )                  |            |                    | 1,506,672  |           
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |           
|Cash flows from financing activities:          |                                                                                                     |                                                |                                          |            |                    |            |                    |           
|                                               | Net proceeds from the issuance of preferred and common stock                                        |                                                |                                          | 4,239,300  |                    |            |                    | 1,753,420  |           
|                                               | Net payments under line of credit                                                                   |                                                |                                          | (1,449,146 | )                  |            |                    | (750,000   | )         
|                                               | Decrease in restricted cash                                                                         |                                                |                                          | 1,360,296  |                    |            |                    | 750,000    |           
|                                               | Payments of notes payable and other long term liabilities                                           |                                                |                                          |           |                    |            |                    | (52,497    | )         
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |            |           
|                                               | Net cash provided by financing activities                                                           |                                                |                                          | 4,150,450  |                    |            |                    | 1,700,923  |           
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |           
|Net decrease in cash and cash equivalents      |                                                                                                     |                                                | (52,486                                  | )          |                    |            | (1,026,946         | )         
|Cash and cash equivalents, beginning of period |                                                                                                     |                                                | 2,246,264                                |            |                    |            | 4,076,894          |           
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |           
|Cash and cash equivalents, end of period       |                                                                                                     | $                                              | 2,193,778                                |            |                    | $          | 3,049,948          |           
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |           
|Cash paid for interest                         |                                                                                                     | $                                              | 237,629                                  |            |                    | $          | 131,446            |           
|                                               |                                                                                                     |                                                |                                          |            |                    |            |                    |           



|SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITY: During the nine months ended
September 30, 2003, the holder of Series A and B Convertible Preferred Stock
converted $1,471,800 of the Preferred Stock into 1,672,500 shares of common
stock of the Company (see Note 10). In addition, during the nine
months ended September 30, 2003, $897,000 of the Companys
working capital line of credit was converted into 975,000 shares
of common stock of the Company (see Note 9).
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

5



---



##### Table of Contents






JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)



|(1) |  | Basis of Presentation and Financial Condition
|--- |  | ---------------------------------------------

The accompanying consolidated financial statements include the accounts of
JMAR Technologies, Inc. (the Company or JMAR) and its subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation. Certain reclassifications have been made to the December 31,
2002 financial statements.

Founded in 1987, we are a semiconductor industry-focused company. JMAR is
the originator of Collimated Plasma Lithography (CPL), a next-generation
lithography (NGL) alternative designed to deliver affordable, sub-100 nanometer
chip-making capability in a compact format to the semiconductor industry.
JMARs operations include its Research Division in San Diego, California, where
research and development of lasers and laser produced plasma generators is
performed; its Systems Division in Burlington, Vermont, where CPL Stepper
Systems and other products are designed and manufactured; and its
Microelectronics Division, based in Sacramento, California, where JMAR provides
process integration and maintenance support for the U.S. Governments Defense
Microelectronics Activity semiconductor fabrication facility.

In the first quarter of 2002, the Company decided to discontinue and sell
its standard semiconductor products business and shift more of its resources to
accelerate the market entry of its CPL products. Also, in furtherance of its
efforts to focus its resources on its CPL business, during the latter half of
2002, the Company concluded that its precision equipment business did not fit
with the strategic direction of the Companys CPL business area and that the
markets for that business products would continue to be slow in the near term.
Therefore, in December, 2002, the Company decided to initiate the process of
selling that business and, in July 2003, the Company completed the
sale of that
business (See Note 14).

The standard semiconductor products business and the precision equipment
business have been accounted for in the accompanying consolidated financial
statements as discontinued operations and the statement of operations for the
three and nine months ended September 30, 2002 has been restated to reflect the
discontinuation of the precision equipment business (See Note 8).

The accompanying consolidated financial statements as of and for the three
and nine months ended September 30, 2003 and 2002, have been prepared by the
Company and are unaudited. The consolidated financial statements have been
prepared in accordance with generally accepted accounting principles, pursuant
to the rules and regulations of the Securities and Exchange Commission. In the
opinion of management, the accompanying consolidated financial statements
include all adjustments of a normal recurring nature which are necessary for a
fair presentation of the results of operations for the interim periods
presented. Certain information and footnote disclosures normally included in
financial statements have been condensed or omitted pursuant to such rules and
regulations.

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates. Although the Company believes that the disclosures are
adequate to make the information presented not misleading, it is suggested that
these interim consolidated financial statements be read in conjunction with the
consolidated financial statements and the notes thereto included in the
Companys Form 10-K for the year ended December 31, 2002. The results of
operations for the three and nine months ended September 30, 2003 are not
necessarily indicative of the results to be expected for the full year.

The Company incurred significant losses for the nine months ended
September 30, 2003 and for the years ended December 31, 2002 and 2001. As of
September 30, 2003, the Company has stockholders equity of approximately $3.9
million and working capital of approximately $174,000. Management has taken
steps to reduce its future cash flow requirements through the discontinuance of
its

6



---



##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)

standard semiconductor products and precision equipment businesses
mentioned above. Additionally, management has completed additional debt and
preferred stock financings in the first and third quarters of 2003 (see Notes 9
and 10). Management believes that the Company has adequate resources to fund
its operations and working capital requirements through September 30, 2004
except for $1.2 million in debt due in February, 2004 to the former creditors
of SAL, Inc., which the Company acquired in August, 2001. Of this
amount, approximately $222,000 is owed to related parties. The Company has had
discussions with the representative of the noteholders of this debt regarding
the extinguishment of this debt with stock or otherwise amending the terms of
the debt. If the Company is unsuccessful in its negotiations with the
noteholders, it will need to raise additional financing to retire this
debt. In November 2003, the Company received $1 million in
funding under its DARPA contract and is expecting additional funding of $1.6 million before
December 31, 2003, the receipt of which is based on
certain milestones. If this funding is not received, the Company may need to
obtain financing to continue this work. The Company expects to
receive approximately $5.4 million in additional funding under
its DARPA contract for 2004. Because of normal delays in the release
of such funding, in the first quarter of
2004, the Company expects a delay in receipt of these funds
which may require the Company to obtain financing for the costs incurred on this contract prior to the
receipt of funds. In addition, the Company has determined that it
will require additional financing to complete or accelerate the
development of some of its high value emerging new products, including
its patented CPL systems for the manufacture of high-performance
semiconductors. There can be no assurance that additional financings will be
available when needed, or if available, will be done on favorable terms.



|(2) |  | Recent Accounting Pronouncements
|--- |  | --------------------------------

In September 2001, FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations (SFAS No. 143). This statement addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. It
applies to (a) all entities and (b) legal obligations associated with the
retirement of long-lived assets that result from the acquisition, construction,
development and/or normal operation of long-lived assets, except for certain
obligations of lessees. This statement amends FASB Statement No. 19, Financial
Accounting and Reporting by Oil and Gas Producing Companies, and is effective
for financial statements issued for fiscal years beginning after September 15,
2002. The Company has implemented SFAS No. 143 effective January 1, 2003. The
impact of such adoption is not anticipated to have a material effect on the
Companys financial statements.

In November 2002, the EITF reached a consensus on Issue 00-21, titled
Accounting for Revenue Arrangements with Multiple Deliverables, which
addresses how to account for arrangements that involve the delivery or
performance of multiple products, services, and/or rights to use assets.
Revenue arrangements with multiple deliverables are divided into separate units
of accounting if the deliverables in the arrangement meet the following
criteria: (1) the delivered item has value to the customer on a standalone
basis; (2) there is objective and reliable evidence of the fair value of
undelivered items; and (3) delivery of any undelivered item is probable.
Arrangement consideration should be allocated among the separate units of
accounting based on their relative fair values, with the amount allocated to
the delivered item being limited to the amount that is not contingent on the
delivery of additional items or meeting other specified performance conditions.
The new standard is required to be adopted for all new applicable revenue
arrangements no later than the third quarter of 2003. Management believes the
implementation of EITF 00-21 will not have a material effect on the Companys
financial statements.

The FASB has issued Interpretation No. 46, Consolidation of Variable
Interest Entities  an interpretation of Accounting Research Bulletin (ARB)
No. 51. This Interpretation defines a variable interest entity and provides
that if a business enterprise has a controlling financial interest in a
variable interest entity, the assets, liabilities, and results of the
activities of the variable interest entity should be included in consolidated
financial statements with those of the business enterprise. Furthermore, the
Board indicates that the voting interest approach of ARB No. 51 is not
effective in identifying controlling financial interests in entities that are
not controllable through voting interest or in which the equity investors do
not bear the residual economic risk. This Interpretation applies immediately
to variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date.
It applies in the first fiscal year or interim period beginning after September
15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. Management believes the
implementation of this Interpretation will not have a material effect upon the
Companys financial statements.

7



---



##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)

In May 2003 FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, which
requires that certain financial instruments previously presented as equity or
temporary equity be presented as liabilities. Such instruments include
mandatory redeemable preferred and common stock, and certain options and
warrants. SFAS 150 is effective for financial instruments issued, entered into
or modified after May 31, 2003 and is generally effective at the beginning of
the first interim period beginning after September 15, 2003. The adoption of
SFAS 150 did not have a material effect on the Companys financial
position or results of its operations.



|(3) |  | Stock-Based Compensation Plans
|--- |  | ------------------------------

The Company has six stock option or warrant plans: the 1991 Stock Option
Plan (the 1991 Plan), the 1999 Stock Option Plan (the 1999 Plan), the
Management Anti-Dilution Plan (the Anti-Dilution Plan), two incentive plans
which provide for the issuance of options and warrants to Research Division
employees (the Research Division Plans), and an incentive plan which provides
for the issuance of options to Microelectronics Division employees (the
Microelectronics Division Plan). The Company may also from time-to-time enter
into equity compensation agreements with individuals that are not covered by a
plan and currently is a party to non-plan option and warrant agreements with
several individuals. The Company accounts for these plans under APB Opinion No.
25 using the intrinsic value method, under which no compensation cost has been
recognized. Had compensation cost for these plans been determined using the
fair value method under SFAS No. 123, the Companys loss
applicable to common stock and loss per share
would have been the following pro forma amounts (unaudited):

|                                 |                 |             |           |   |            |       |                    |   |                   |       |      |   |            |       |   |   |            |       |   |  | 
|-------------------------------- | --------------- | ----------- | --------- | - | ---------- | ----- | ------------------ | - | ----------------- | ----- | ---- | - | ---------- | ----- | - | - | ---------- | ----- | - |  | 
|                                 |                 |             |           |   |            |       | Three Months Ended |   | Nine Months Ended
|                                 |                 |             |           |   |            |       | September 30,      |   | September 30,    
|                                 |                 |             |           |   |            |       |                    |   |                  
|                                 |                 |             |           |   |            |       | 2003               |   | 2002              |       | 2003 |   | 2002      
|                                 |                 |             |           |   |            |       |                    |   |                   |       |      |   |           
|Loss
applicable to common stock: |                 | As Reported |           | $ | (1,063,451 | )     |                    | $ | (2,836,656        | )     |      | $ | (3,536,745 | )     |   | $ | (4,586,442 | )    
|                                 |                 | Pro Forma   |           |   | (1,943,476 | )     |                    |   | (4,544,458        | )     |      |   | (4,488,026 | )     |   |   | (6,330,208 | )    
|Basic and diluted                |                 | As Reported |           |   | (0.04      | )     |                    |   | (0.12             | )     |      |   | (0.14      | )     |   |   | (0.20      | )    
|                                 | loss per share: |             | Pro Forma |   |            | (0.08 | )                  |   |                   | (0.19 | )    |   |            | (0.18 | ) |   |            | (0.27 | )

The fair value of each option and warrant grant is estimated on the date
of grant using the Black-Scholes option pricing model with the following
weighted-average assumptions: risk-free interest rate of approximately 2.74
percent (4 percent in 2002); expected dividend yields of 0 percent; expected
lives of 6 years and expected volatility of 142 percent.

The Company was authorized to grant options or warrants to its employees
(including directors) and consultants for up to 1,480,000 shares under the 1991
Plan, 1,900,000 shares under the 1999 Plan, 806,637 shares under the
Anti-Dilution Plan, 350,000 shares under the Research Division Plans, and
25,000 shares under the Microelectronics Division Plan (the Plans). In
addition, the Company currently has outstanding options to purchase 613,000
shares granted to several individuals outside of the Plans. Under all Plans,
the option or warrant exercise price is equal to or more than the stocks
market price on date of grant. During the quarter ended
September 30, 2003, 10,000
options were granted pursuant to the 1999 Plan.



|(4) |  | Inventories
|--- |  | -----------

Inventories are carried at the lower of cost (on the first-in, first-out
basis) or market and are comprised of materials, direct labor and applicable
manufacturing overhead. At September 30, 2003 and December 31, 2002,
inventories consisted of the following:

8



---



##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)

|                                             |  |                    |         |                   |  |   |         | 
|-------------------------------------------- |  | ------------------ | ------- | ----------------- |  | - | ------- | 
|                                             |  | September 30, 2003 |         | December 31, 2002
|                                             |  |                    |         |                  
|                                             |  | (Unaudited)        |         |                   |  |  
|Raw materials, components and sub-assemblies |  | $                  | 215,143 |                   |  | $ | 222,077 | 
|Work-in-process                              |  |                    | 83,856  |                   |  |   | 125,315 | 
|Finished goods                               |  |                    | 47,125  |                   |  |   | 42,075  | 
|                                             |  |                    |         |                   |  |   |         | 
|                                             |  | $                  | 346,124 |                   |  | $ | 389,467 | 
|                                             |  |                    |         |                   |  |   |         | 



|(5) |  | Property and Equipment
|--- |  | ----------------------

At September 30, 2003 and December 31, 2002, property and equipment
consisted of the following:

|                              |  |                    |            |                   |  |   |            |  
|----------------------------- |  | ------------------ | ---------- | ----------------- |  | - | ---------- | -
|                              |  | September 30, 2003 |            | December 31, 2002
|                              |  |                    |            |                  
|                              |  | (Unaudited)        |            |                   |  |  
|Equipment and machinery       |  | $                  | 2,772,216  |                   |  | $ | 2,983,443  |  
|Furniture and fixtures        |  |                    | 435,042    |                   |  |   | 420,188    |  
|Leasehold improvements        |  |                    | 280,283    |                   |  |   | 280,283    |  
|                              |  |                    |            |                   |  |   |            |  
|                              |  |                    | 3,487,541  |                   |  |   | 3,683,914  |  
|Less-accumulated depreciation |  |                    | (2,618,764 | )                 |  |   | (2,435,716 | )
|                              |  |                    |            |                   |  |   |            |  
|                              |  | $                  | 868,777    |                   |  | $ | 1,248,198  |  
|                              |  |                    |            |                   |  |   |            |  

During 2003, the Company wrote-off a $200,056 asset that will not be used
by the Company in the future.



|(6) |  | Segment Information
|--- |  | -------------------

In the first quarter of 2002, the Company decided to discontinue and sell
its standard semiconductor products business and shift more of its resources to
accelerate the market entry of its CPL products. Also, in furtherance of its efforts to focus its resources on its CPL business,
during the later half of 2002, the Company concluded that the precision
equipment business did not fit with the strategic direction of the Companys
CPL business area and that the markets for that segments products would
continue to be slow in the near term. Therefore, in December, 2002, the
Company decided to initiate the process of selling this business and
in July 2003, the Company completed the sale of that business (See
Note 14).

As a result of these decisions, and to streamline the Companys operations
and better support the commercialization of its emerging CPL semiconductor
manufacturing systems and related technologies, the Company now operates in
three business segments, as follows:

Research Division (formerly JMAR Research)  This segments role is as an
innovator of laser and laser-produced plasma technologies for the Companys CPL
Source, EUV generators, and related products such as high-brightness lasers.
During the nine months ended September 30, 2003 and 2002, this segment
accounted for approximately 33% and 37%, respectively, of the Companys
revenues.

Systems Division (formerly JMAR/SAL NanoLithography)  This segment
encompasses the development of X-ray lithography steppers, and the product
engineering, production and integration of CPL light sources and complete CPL
stepper systems. During the nine months ended September 30, 2003 and 2002,
this segment accounted for approximately 41% and 48%, respectively, of the
Companys revenues.

9



---



##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)

Microelectronics Division  In 2002, JMAR discontinued the standard
products business and the assets of its Sacramento operations were sold to JSI
Microelectronics, Inc., a wholly-owned subsidiary of the Company, now the
Microelectronics Division. This segment provides process integration and
maintenance support for the Defense Microelectronics Activity semiconductor
fabrication facility in Sacramento, California, and ASIC design and production
capability for the military and commercial markets. During the nine months
ended September 30, 2003 and 2002, this segment accounted for approximately 26%
and 15%, respectively, of the Companys revenues.

The accounting policies of the reportable segments are the same as those
described in Note 2 of the Companys Form 10-K for the year ended December 31,
2002. The Company evaluates the performance of its operating segments
primarily based on revenues and operating income. Corporate costs are
generally allocated to the segments.

Segment information for the three and nine months ended September 30, 2003
and 2002 (excluding discontinued operations) is as follows (2002 has been
restated to reflect the new business segments):

|                                       |  |                               |  |          |           |          |  |                  |            |           |  |       |           |  |  |   |            |   |  |   |            |  
|-------------------------------------- |  | ----------------------------- |  | -------- | --------- | -------- |  | ---------------- | ---------- | --------- |  | ----- | --------- |  |  | - | ---------- | - |  | - | ---------- | -
|                                       |  |                               |  | Research |           | Systems  |  | Microelectronics |            |           |  |       |           |  |  |  
|                                       |  |                               |  | Division |           | Division |  | Division         |            | Corporate |  | Total
|                                       |  |                               |  |          |           |          |  |                  |            |           |  |      
|Nine Months Ended
September 30, 2003:  |  |                               |  |          |           |          |  |                  |            |           |  |       |           |  |  |   |            |   |  |  
|                                       |  | Revenues                      |  | $        | 4,494,234 |          |  | $                | 5,619,409  |           |  | $     | 3,612,655 |  |  | $ |           |   |  | $ | 13,726,298 |  
|                                       |  | Asset writedown               |  |          | (200,056  | )        |  |                  |           |           |  |       |          |  |  |   |           |   |  |   | (200,056   | )
|                                       |  | Operating income (loss)       |  |          | 65,849    |          |  |                  | (1,189,193 | )         |  |       | 159,016   |  |  |   | (267,568   | ) |  |   | (1,231,896 | )
|                                       |  | Total assets                  |  |          | 2,775,678 |          |  |                  | 5,318,845  |           |  |       | 1,289,918 |  |  |   | 2,497,641  |   |  |   | 11,882,082 |  
|                                       |  | Goodwill                      |  |          |          |          |  |                  | 3,790,907  |           |  |       |          |  |  |   |           |   |  |   | 3,790,907  |  
|                                       |  | Capital expenditures          |  |          | 33,324    |          |  |                  | 2,578      |           |  |       | 13,281    |  |  |   | 7,881      |   |  |   | 57,064     |  
|                                       |  | Depreciation and
amortization |  |          | 175,590   |          |  |                  | 236,831    |           |  |       | 17,614    |  |  |   | 253,519    |   |  |   | 683,554    |  
|Three Months Ended
September 30, 2003: |  |                               |  |          |           |          |  |                  |            |           |  |       |           |  |  |   |            |   |  |  
|                                       |  | Revenues                      |  |          | 1,440,942 |          |  |                  | 1,520,045  |           |  |       | 1,003,943 |  |  |   |           |   |  |   | 3,964,930  |  
|                                       |  | Operating income (loss)       |  |          | 62,952    |          |  |                  | (377,130   | )         |  |       | 54,223    |  |  |   | (49,685    | ) |  |   | (309,640   | )
|                                       |  | Capital expenditures          |  |          | 1,602     |          |  |                  |           |           |  |       | 2,562     |  |  |   | 4,358      |   |  |   | 8,522      |  
|                                       |  | Depreciation and
amortization |  |          | 58,096    |          |  |                  | 75,026     |           |  |       | 6,729     |  |  |   | 20,633     |   |  |   | 160,484    |  
|Nine Months Ended
September 30, 2002:  |  |                               |  |          |           |          |  |                  |            |           |  |       |           |  |  |   |            |   |  |  
|                                       |  | Revenues                      |  |          | 5,418,556 |          |  |                  | 7,007,957  |           |  |       | 2,230,397 |  |  |   |           |   |  |   | 14,656,910 |  
|                                       |  | Special item                  |  |          |          |          |  |                  |           |           |  |       |          |  |  |   | (1,074,324 | ) |  |   | (1,074,324 | )
|                                       |  | Operating income (loss)       |  |          | 397,401   |          |  |                  | (444,725   | )         |  |       | 290,001   |  |  |   | (1,950,058 | ) |  |   | (1,707,381 | )
|                                       |  | Total assets                  |  |          | 5,400,967 |          |  |                  | 6,715,704  |           |  |       | 861,698   |  |  |   | 3,455,123  |   |  |   | 16,433,492 |  
|                                       |  | Goodwill                      |  |          |          |          |  |                  | 3,790,907  |           |  |       |          |  |  |   |           |   |  |   | 3,790,907  |  
|                                       |  | Capital expenditures          |  |          | 207,635   |          |  |                  | 56,495     |           |  |       | 24,031    |  |  |   | 1,048      |   |  |   | 289,209    |  
|                                       |  | Depreciation and
amortization |  |          | 162,196   |          |  |                  | 230,654    |           |  |       | 8,834     |  |  |   | 63,580     |   |  |   | 465,264    |  
|Three Months Ended
September 30, 2002: |  |                               |  |          |           |          |  |                  |            |           |  |       |           |  |  |   |            |   |  |  
|                                       |  | Revenues                      |  |          | 3,294,434 |          |  |                  | 2,140,867  |           |  |       | 1,027,332 |  |  |   |           |   |  |   | 6,462,633  |  
|                                       |  | Special item                  |  |          |          |          |  |                  |           |           |  |       |          |  |  |   | (1,074,324 | ) |  |   | (1,074,324 | )
|                                       |  | Operating income (loss)       |  |          | 203,390   |          |  |                  | (301,869   | )         |  |       | 36,351    |  |  |   | (1,409,154 | ) |  |   | (1,471,282 | )
|                                       |  | Capital expenditures          |  |          | 149,481   |          |  |                  |           |           |  |       | 24,031    |  |  |   |           |   |  |   | 173,512    |  
|                                       |  | Depreciation and
amortization |  |          | 60,474    |          |  |                  | 78,942     |           |  |       | 6,616     |  |  |   | 21,441     |   |  |   | 167,473    |  

The asset writedown for 2003 of $200,056 relates to an asset held by the
Research Division that will not be used by the Company in the future. The
special item for 2002 of $1,074,324 relates to the retirement benefits in
August 2002 of the Companys former Chairman and Chief Executive Officer.

10



---



##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)

Sales to the United States Government aggregated $2,685,466, $8,610,484,
$4,679,389 and $10,618,745 for the three and nine months ended September 30,
2003 and 2002, respectively. In addition, sales to General Dynamics Advanced
Information Systems were $948,525, $3,504,632, $1,027,332 and $2,028,028 for
the three and nine months ended September 30, 2003 and 2002, respectively.



|(7) |  | Comprehensive Loss
|--- |  | ------------------

The other comprehensive loss for the nine months ended September 30, 2002
represents the Companys investment in Bede plc (Bede). In January 2002, the
Company sold its remaining 545,500 shares of its investment in Bede for net
proceeds of approximately $1.4 million. The gain from that transaction of
$1,349,721 is included in this Consolidated Statement of Operations for the
nine months ended September 30, 2002. For the three and nine months ended
September 30, 2003, the Company did not have any elements of comprehensive
income or loss, and therefore, there was no difference in the Companys net
loss and comprehensive loss for that period. For the nine months ended
September 30, 2002, the Company had an additional unrealized loss on marketable
securities of $75,143 for the period from January 1, 2002 to the sale date of
the securities, however, that loss was realized as a result of the sale of the
securities.



|(8) |  | Discontinued Operations/Assets Held for Sale
|--- |  | --------------------------------------------

The loss from operations of discontinued operations of $258,673 and
$1,405,490 for the three and nine months ended September 30, 2003 includes
$155,526 and $467,503, respectively, related to the standard semiconductor
products business and $103,147 and $937,987, respectively, related to the
precision equipment business. In July 2003, the Company sold JPSI, exclusive of
certain assets and liabilities, to several private investors (see Note 14). In
accordance with SFAS No. 144, the results of operations of the precision
equipment business for 2003 through the sale date are reported in discontinued
operations. The gain on disposal of discontinued operations of $205,000 for the
three and nine months ended September 30, 2003 relates to the
sale of JPSI.

In September 2000, JSI moved into a significantly larger facility in
anticipation of realizing its growth plans. Prior to December 31, 2001, the
Company decided to take action to sublease that facility and move JSI into a
smaller facility. The Company does not yet have a subtenant for this facility
and, as of September 30, 2003, the Company has approximately $577,000 accrued
for estimated future losses under this lease. The lease provides for rent and
related expenses of approximately $36,000 per month through August 2005. If the
Company is unsuccessful in obtaining a subtenant on acceptable terms, there
could be further losses related to that lease.

At September 30, 2003 and December 31, 2002, net assets and liabilities of
assets held for sale consisted of the following:

|                |                            |   |               |        |              |   |           |         | 
|--------------- | -------------------------- | - | ------------- | ------ | ------------ | - | --------- | ------- | 
|                |                            |   | September 30, |        | December 31,
|                |                            |   | 2003          |        | 2002        
|                |                            |   |               |        |             
|                |                            |   | (Unaudited)   |        |              |   |          
|Current Assets: |                            |   |               |        |              |   |           |        
|                | Cash                       |   | $             | 21,389 |              |   | $         | 101,238 | 
|                | Accounts receivable        |   |               | 90,216 |              |   |           | 454,557 | 
|                | Inventories                |   |               |       |              |   |           | 727,983 | 
|                | Prepaid expenses and other |   |               | 18,214 |              |   |           | 65,980  | 
|                |                            |   |               |        |              |   |           |        
|                |                            | $ | 129,819       |        |              | $ | 1,349,758 |        
|                |                            |   |               |        |              |   |           |        

11



---



##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)

|                     |                                          |   |               |         |              |   |           |           | 
|-------------------- | ---------------------------------------- | - | ------------- | ------- | ------------ | - | --------- | --------- | 
|                     |                                          |   | September 30, |         | December 31,
|                     |                                          |   | 2003          |         | 2002        
|                     |                                          |   |               |         |             
|                     |                                          |   | (Unaudited)   |         |              |   |          
|Current Liabilities: |                                          |   |               |         |              |   |           |          
|                     | Payable to distributor                   |   | $             | 500,000 |              |   | $         | 692,314   | 
|                     | Facility lease accrual                   |   |               | 730,178 |              |   |           | 548,374   | 
|                     | Accounts payable                         |   |               | 260,932 |              |   |           | 1,154,463 | 
|                     | Employee related contractual commitments |   |               | 98,561  |              |   |           | 555,000   | 
|                     | Note payable                             |   |               | 138,656 |              |   |           | 175,000   | 
|                     |                                          |   |               |         |              |   |           |          
|                     |                                          | $ | 1,728,327     |         |              | $ | 3,125,151 |          
|                     |                                          |   |               |         |              |   |           |          



|(9) |  | Line of Credit
|--- |  | --------------

In March 2003, the Company entered into a Revolving Fixed Price
Convertible Note (the Working Capital Line) with Laurus Master Fund
(Laurus) replacing its previous bank credit agreement, which had a
compensating balance of $1.5 million at December 31, 2002. The Working Capital
Line allows the Company to borrow from time-to-time up to 85% of eligible
accounts receivable of the Company to a maximum of $3 million. The Company can
convert a portion of the principal outstanding under the Working Capital Line
to common stock at $.92 per share (the Conversion Price) if the market price
of the Companys common stock averages 118% of the Conversion Price or higher
for 22 consecutive trading days. Laurus can convert any portion of the
principal outstanding to common stock at the Conversion Price any time the
market price of the Companys common stock is in excess of the Conversion
Price. After the first $2 million of conversions into common stock, the
Conversion Price will be adjusted upward if the average stock prices at that
time are above the Conversion Price. In the nine months ended September 30,
2003, Laurus converted $897,000 of the Working Capital Line into 975,000 shares
of Common Stock of the Company. The interest rate on the Working Capital Line
is prime (4 percent at September 30, 2003) plus .75 percent, subject to a floor
of 5 percent. The amount outstanding at September 30, 2003 under the Working
Capital Line was approximately $100,000, net of discount of approximately
$88,000, and the maximum amount borrowed during 2003 was approximately $2.5
million. The Working Capital Line also requires the Company to meet certain
financial covenants. The term of the Working Capital Line runs until March,
2006. The available borrowings under the Working Capital Line were
approximately $2 million at September 30, 2003.



|(10) |  | Equity Transactions
|---- |  | -------------------

In February 2003, under its Shelf Registration Statement, the Company sold
100,000 shares of its common stock for gross proceeds of $100,000. In
connection with this transaction, the Company issued to the purchaser warrants
to purchase 20,000 shares of its common stock at an exercise price of $1.25 per
share and a term of three years.

In March 2003, the Company sold for cash, under its Shelf Registration
Statement, $1 million of 8 percent Series A Convertible Preferred Stock
(Series A Preferred) to Laurus which are convertible
at any time by Laurus at a fixed conversion price of $.88 per share.
The Series A Preferred is redeemable in two years, if not previously
converted. Except for the conversion price, the conversion terms of the Series
A Preferred are the same as the conversion terms of the Working Capital Line.
The proceeds received under the Series A Preferred were initially restricted,
however, the funds are released as the Preferred Stock is converted to common
stock. During the nine months ended September 30, 2003, Laurus converted
$780,296 of the Series A Preferred into 886,700 shares of common stock of the
Company. As of September 30, 2003, restricted cash was $189,704. The amount of
Series A Preferred outstanding at September 30, 2003 was $219,704, net of
discount of $35,015.

In addition, in March, 2003, the Company sold for cash, under its Shelf
Registration Statement, $1 million of 3 percent Series B Convertible Preferred
Stock (Series B Preferred) to Laurus which are convertible
at any time by Laurus at a fixed conversion price of $.88 per
share. The Series B Preferred is redeemable in cash or stock (if the closing
market price of the Companys common stock is 118% of the Conversion Price or
higher for the 11 trading days prior to the redemption date) in twelve equal
monthly installments of $83,333 starting October 1,

12



---



##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)

2003, if not previously converted. Conversions to equity are offset
against the required repayments and, as a result of conversions to date, the
first installment payment is scheduled for June 2004. Except for the conversion
price, the conversion terms of the Series B Preferred are the same as the
conversion terms of the Working Capital Line. In the nine months ended
September 30, 2003, Laurus converted $691,504 of the Series B Preferred into
785,800 shares of common stock of the Company. The amount of Series B Preferred
outstanding at September 30, 2003 was $308,496, net of discount of $67,350.

In connection with all of the above financing transactions with Laurus,
the Company issued to Laurus warrants to purchase 550,000 shares of common
stock at prices ranging from $1.058 to $1.33 and a term of seven years. In addition, Laurus will be
issued a warrant to purchase one share of common stock for every $20 of
principal under the Working Capital Line converted to equity, up to a total of
150,000 shares, at an exercise price of $1.15 per share. The Company valued all
of these warrants using the Black-Scholes model and recorded the fair value of
$374,000 as a discount to the convertible debt and preferred stock. As a result
of the convertible securities issued to Laurus described above, the Company
recorded an additional discount of $444,000 representing the intrinsic value of
the beneficial conversion feature for the convertible debt and preferred stock,
which will be amortized over the redemption period of the preferred stock and
the life of the debt using the effective interest method.

In September 2003, the Company sold for cash $1.5 million of 8 percent
Series C Convertible Preferred Stock (Series C Preferred) to Laurus which are convertible
at any time by Laurus at a
fixed conversion price of $2.08 per share. The Series C Preferred is
redeemable in cash or stock (if the closing market price of the Companys
common stock is 118% of the Conversion Price or higher for the 11 trading days
prior to the redemption date) in twelve equal monthly installments starting in
April, 2004, if not previously converted. Conversions to equity are offset
against the required repayments. Except for the conversion price, the
conversion terms of the Series C Preferred are the same as the conversion terms
of the Working Capital Line. The amount of Series C Preferred outstanding at
September 30, 2003 was $1.5 million, net of discount of $474,598.

In connection with the September 2003 financing, the Company issued to
Laurus warrants to purchase 150,000 shares of common stock at an exercise price
of $2.60 and a term of seven years. The Company valued these warrants using the Black-Scholes model and
recorded the fair value of $201,000 as a discount to the preferred stock. In
addition, the Company recorded an additional discount of $201,000 representing
the intrinsic value of the beneficial conversion feature for the convertible
preferred stock, which will be amortized over the redemption period of the
preferred stock using the effective interest method.

Included in the loss applicable to common stock in the Statement of
Operations for the three and nine months ended September 30, 2003 is preferred
stock dividends of $439,290 and $668,743, respectively. The nine month period
includes $40,113 of dividends paid in cash and $628,630 related to the
beneficial conversion feature. Included in interest expense for the nine months
ended September 30, 2003 is $187,935 related to the beneficial conversion
feature attributable to the convertible debt. In addition, there will be an
additional beneficial conversion feature in the amount of $32,000 recorded as
additional borrowings are made against the Working Capital Line and an
additional beneficial conversion charge of $52,000 will be recorded prorata
upon conversion of the convertible debt for the warrants issued thereon. In
connection with the Preferred Stock issuances, the Company paid Laurus fees of
$172,750 and incurred other costs of approximately $41,000.



|(11) |  | Earnings (Loss) Per Share
|---- |  | -------------------------

The Company accounts for earnings per share in accordance with SFAS No.
128, Earnings per Share. Basic earnings per common share were computed by
dividing loss applicable to common stock by the weighted average number of shares of common stock
outstanding during the period. For the three and nine months ended September
30, 2003 and 2002, the denominator in the diluted loss per share
computation was the same as the denominator for basic loss per share due to
antidilutive effects of the Companys warrants, stock options, convertible debt
and convertible preferred stock. As of September 30, 2003 and 2002, the
Company had shares issuable under outstanding warrants, stock options,
convertible preferred stock and

13



---



##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)

convertible debt of 7,824,029 and 4,313,575, respectively, all of which
are antidilutive and were excluded from the computation of diluted loss per
share.



|(12) |  | Intangible Assets
|---- |  | -----------------

The Company adopted Financial Accounting Standards Board No. 142 Goodwill
and Other Intangible Assets (FASB 142) effective January 1, 2002. In
accordance with FASB 142, the Company does not amortize goodwill. The
Companys goodwill of $3,790,907 at September 30, 2003 and December 31, 2002 is
related to the Systems Division, acquired in August 2001. As of September 30,
2003, the Company had the following amounts related to other intangible assets:

|                      |  |                |         |              |  |                |         |  |  |   |         | 
|--------------------- |  | -------------- | ------- | ------------ |  | -------------- | ------- |  |  | - | ------- | 
|                      |  | Gross Carrying |         | Accumulated  |  | Net Intangible
|                      |  | Amount         |         | Amortization |  | Assets        
|                      |  |                |         |              |  |               
|Patents               |  | $              | 940,219 |              |  | $              | 386,447 |  |  | $ | 553,772 | 
|Unpatented Technology |  |                | 450,000 |              |  |                | 336,056 |  |  |   | 113,944 | 
|                      |  |                |         |              |  |                |         |  |  |   |         | 
|                      |  |                |         |              |  |                |         |  |  | $ | 667,716 | 
|                      |  |                |         |              |  |                |         |  |  |   |         | 

Aggregate amortization expense of the intangible assets with determinable
lives was $69,826 and $209,419 for the three and nine months ended September
30, 2003, respectively. The unamortized balance of intangible assets is
estimated to be amortized as follows:

|                   |      |                        |         |         | 
|------------------ | ---- | ---------------------- | ------- | ------- | 
|For the Year Ended |      | Estimated Amortization
|December 31,       |      | Expense               
|                   |      |                       
|                   | 2003 |                        | $       | 68,801  | 
|                   | 2004 |                        |         | 182,002 | 
|                   | 2005 |                        |         | 23,362  | 
|                   | 2006 |                        |         | 23,362  | 
|                   | 2007 |                        |         | 23,362  | 
|                   | 2008 |                        |         | 23,361  | 
|Beyond             |      |                        | 323,466 |        
|                   |      |                        |         |        
|                   |      | $                      | 667,716 |        
|                   |      |                        |         |        



|(13) |  | Legal Proceedings
|---- |  | -----------------

All American Lawsuit

Following the discontinuance of the standard semiconductor products
business of JMAR Semiconductor, Inc. (JSI) in the first quarter of 2002, JSI
sought to negotiate debt reductions from the creditors associated with the
discontinued portion of its business. Among the debts of JSI was a debt of
approximately $700,000 to its distributor, All American Semiconductor, Inc.
(All American). Although the Company asserts that the debts of JSI are the
sole obligation of JSI and not of the Company, the Company is required to
reflect the liabilities of this subsidiary in its Consolidated
Balance Sheet and the Company has previously reflected approximately $700,000
owing to All American as a liability on its Consolidated Balance Sheet. In
September, 2002, All American filed a Complaint against JSI and JMAR in San
Diego Superior Court seeking payment of the $700,000 debt and other
damages. All American
alleged that JMAR was the alter ego of JSI and based on that theory should be
held responsible for the obligations of JSI. In September 2003, the Company
and All American executed a settlement agreement whereby the Company agreed to
pay All American $500,000 in full satisfaction of all amounts owed to All
American. The lawsuit was dismissed with prejudice in October, 2003. As a
result of this settlement, the Company recorded a $200,000 gain in discontinued
operations.

14



---



##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited)

Assignment for the Benefit of Creditors and Other JSI Liabilities

After unsuccessfully engaging in efforts to sell the standard chip portion
of JSI, in the fourth quarter of 2002, JSI transferred all of its assets and
liabilities to a third party fiduciary in an assignment for the benefit of
creditors (ABC). Under this state law procedure, the assignee liquidated the
JSI assets and the proceeds, if any, from the sale of those assets (after
satisfaction of the costs of the ABC, including expenses incurred by the third
party fiduciary in defending any litigation over the ABC or its administration
of the claims) will be equitably distributed among the creditors of JSI and the
claims of creditors of JSI are limited to those proceeds. Following the
assignment of those assets, the fiduciary sold those assets to JSI
Microelectronics, Inc., a wholly-owned subsidiary of the Company, at a price
equal to a 10% premium over an independently appraised value of those assets,
with the purchase price consisting of cash, assumption of certain trade debt
owed to suppliers who are critical to the ongoing operations and the waiver of
any claims on debt owed by JSI to the Company. The Company has accounted for
this transaction by recording the purchase of the assets at the lower of cost
or fair value.

Macrotech Lawsuit

Among the remaining liabilities of JSI included on the Companys
Consolidated Balance Sheet is a debt of approximately $200,000 owing to
Macrotech, Inc., a former supplier of chip manufacturing services to JSI. This
debt arises out of several purchase orders for FIFO chip manufacturing issued
by JSI to Macrotech. JSI claims that these purchase orders were cancelable as
to amounts that had not yet been confirmed for production and that JSI timely
canceled all but approximately $200,000 of the remaining obligations under
those purchase orders. In October, 2003, Macrotech
filed a Complaint against JSI alleging breach of contract and other related
claims and seeking payment of approximately $680,000, as well as punitive
damages in an unspecified amount. Macrotech also alleges that the Company is
the alter ego of JSI and should be held responsible for JSIs debts. JSI and
the Company deny that Macrotech is owed more than approximately $200,000 and
the Company asserts that it is not JSIs alter ego and is not responsible for
the debts of JSI. Although the Company believes the parties will continue to
engage in discussions in an effort to avoid the costs of litigation and to
reach a mutual resolution of this matter, if the lawsuit is pursued by Macrotech the Company
intends to vigorously defend this lawsuit.

(14) Sale of JPSI

In July 2003, the Company sold JPSI, exclusive of certain assets and
liabilities, to several private investors. Under the terms of the sale, JMAR
received $500,000 in a combination of cash and non-interest bearing promissory
notes, and the buyer assumed 14 of the remaining 25 months of JPSIs facility
lease. The notes are payable in four equal annual installments of $62,500
starting in December 2004 and are secured by the assets of JPSI and the lease
obligation is secured by personal property of the buyers. The note in the
amount of $250,000, net of discount of $114,610 (using a
discount rate of 30 percent), is included in other assets in
the accompanying Consolidated Balance Sheet. In addition, all JPSI receivables
as of the closing (approximately $418,000) were assigned to JMAR and JMAR
agreed to pay all trade and employee related liabilities existing as of the
closing (approximately $320,000) and unknown liabilities, if any. The buyers
have assumed all other ongoing commitments of JPSI. In accordance with SFAS No.
144, the results of operations of the precision equipment business for 2003
through the sale date are reported in discontinued operations. Included in the
Statement of Operations for the three and nine months ended September 30, 2003
is a gain on the sale of JPSI of $205,000.

15



---



##### Table of Contents






MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Item 2.

Overview and Business Strategy

JMAR Technologies, Inc. is a developer of collimated laser plasma
lithography (CPL) light sources and stepper systems for advanced semiconductor
chip manufacturing. These systems are based on the Companys proprietary and
patented solid state laser systems and its expertise in laser plasma-generated
X-rays. The development of the Companys CPL source and stepper systems has
been, and continues to be, principally funded by the U.S. Defense Advanced
Research Projects Agency (DARPA). The Company plans initially to sell advanced
CPL systems to manufacturers of Gallium Arsenide (GaAs) semiconductors used in
high performance military electronics and high speed communications. The
Company has also identified an opportunity for its CPL source technology to
pattern contact holes on silicon semiconductor wafers. With investment and
support from strategic partners and other sources, the Companys ultimate goal
is to achieve significant growth in revenue and earnings through the production
of CPL light sources for the multi-billion dollar silicon-based semiconductor
manufacturing industry. CPL has the potential to complement 193nm lithography
at the 90nm through 45nm nodes for contact hole patterning and may prove a cost
effective adjunct to more costly Next Generation Lithography technologies,
such as EUV, at the 32nm node and beyond.

Our program to produce CPL sources for semiconductor lithography has
proven to be technologically challenging, evolving over the past decade from
scientific research and development, to laboratory proof of concept, to the
current beta stage. In 2003 we successfully integrated our CPL source with
our Systems Division X-ray stepper and printed high quality patterns on wafers.
Our initial operating experience with the beta CPL source taught us that
fundamental engineering refinement is necessary to achieve the levels of power
stability and operational reliability needed for sustained lithography
operations. We made the management decision to start work on a second CPL
source that will retain many of the design elements of the existing CPL source,
but embodies new engineering solutions where necessary. This decision also
involved proactive steps to complement Research Divisions traditional
excellence in laser science with a team of skilled mechanical, electrical and
software engineers.

This new team of engineers is working to increase the X-ray power output
and reliability of our CPL source to meet the needs of GaAs chip manufacturing
and other applications. We believe that this work will continue to be largely
funded by our DARPA contract, but could require financing beyond the funding
provided by the Companys government contracts. Failure to resolve these
challenges within the timeframe
demanded by potential customers may have an adverse impact on the success of
our efforts to manufacture and sell our CPL systems. In addition, the Companys
cost models contemplate that multiple suppliers will emerge and greater volume purchases of
high cost components will result in reduced CPL source manufacturing costs and
appropriate gross margins.

CPL offers dramatically increased GaAs wafer throughput, as compared to
direct-write e-beam lithography. The GaAs market is not expanding at the fast
pace predicted three years ago because of the decline in the telecom industry,
and so the demand for increased throughput offered by the Companys CPL system
has been delayed. Although the Company plans to enter this market when it
recovers, it cannot estimate when it will receive its first CPL system order
for the GaAs market. JMAR is currently upgrading its CPL source to achieve 45
watts of X-ray power with high reliability to be better prepared for the GaAs
markets recovery.

The Company believes that its CPL source technology is a viable candidate
to meet the semiconductor industrys need to produce better contact holes in
semiconductor chips. The Company is preparing to pattern the contact hole layer
of silicon wafers so that qualified third parties can compare the quality of
contact holes produced by CPL with the quality of those produced by
state-of-the-art optical lithography. In order to enter the silicon contact
hole market in 2005, the Company must form an alliance with a stepper company
in 2004 to develop this specialty lithography tool for this
higher-throughput, larger wafer-size market. In addition, we must
continue to improve the
CPL source reliability, increase its power output to meet industry
throughput requirements, and reduce the
projected manufacturing cost. Additionally the infrastructure for masks,
resist, and metrology must be improved.

16



---



##### Table of Contents



After introducing CPL to the contact hole segment of the silicon market,
the Company plans to position itself to sell its Sources more broadly to the
mainstream silicon market no earlier than 2006. In addition to the above
improvements, the Company may be required to further increase the power of the
CPL source for greater throughput. Mainstream silicon lithography success also
depends on improvements in mask writer placement accuracy and development of
improved membrane mask deflection and correction techniques to achieve high
overlay accuracy.

Since July, 2002, the Company has been working actively to establish
strong alliances with the semiconductor industry to deliver CPL to the
mainstream silicon market. In December, 2002, SG Cowen Securities Corporation
was retained to advise the Company on identifying, contacting and negotiating
transactions with prospective alliance parties. JMAR is continuing these
efforts, but does not yet have a
commitment from an industry partner. We are, however, optimistic that once the
beta CPL stepper system is fully operational and reliable, we will make faster
progress in forming an alliance that brings together the industry support
needed to move CPL forward.

Achieving market acceptance for our new and proposed CPL products requires
a significant effort to convince semiconductor manufacturers to adopt the
Companys CPL technology over other alternative lithography technologies. This
will require substantial technical, marketing and sales efforts and the
expenditure of significant funds. Currently, the semiconductor industry is exploring several
different technologies for its near-term and long-term lithography needs, some
of which currently have greater acceptance than CPL.

In addition to its CPL efforts, the Company is pursuing other laser
produced plasma (LPP) applications. JMAR has worked with the University of
Central Florida over the past three years to develop LPP based Extreme
Ultraviolet (EUV) lithography light source technology. The knowledge and IP
resulting from this work positions JMAR to participate in EUV Source
development on a contract basis. JMAR is also investigating opportunities to
use its LPP X-ray source technology in non-lithography applications. As an
example, JMARs CPL technology may enable development of a table top X-ray
microscope for the research and biotech communities. X-ray microscopy currently
requires use of a synchrotron facility.

The
Companys Systems Division is working to expand its previously
announced relationship with
FemtoTrace for the production of advanced sensor systems (READ) by marketing
this ultra sensitive sensor technology for military and Homeland Security
applications.

The Companys Microelectronics Division provides semiconductor process
integration services under contracts that support the Department of Defenses
mission to ensure a supply of semiconductor products for military systems. This
Division is also in the custom application specific integrated circuit (ASIC)
business. It seeks to increase its revenue base by expanding its ASIC business
to include power management chip fabrication.

Business Segments

Through December 31, 2001, the Company operated in three segments as
follows: Front-end Semiconductor Equipment and Services, Precision Equipment,
and Semiconductor Products and Processes. In the first quarter of 2002, the
Company decided to discontinue its standard semiconductor products business and
shift more of its resources to accelerate the market entry of its CPL products.

In furtherance of its efforts to focus its resources on its CPL and LPP
business, the Company concluded during the latter half of 2002 that the
precision equipment business did not fit with the strategic direction of the
Companys CPL business area and that the markets for that segments products
would continue to be slow in the near term. Therefore, in December, 2002, the
Company decided to initiate the process of selling that business and, in July
2003, the Company completed the sale of that business.

The standard semiconductor products business and the precision equipment
business have been accounted for in the accompanying consolidated financial
statements as discontinued operations and the

17



---



##### Table of Contents



statement of operations for the
three and nine months ending September 30, 2002 has been restated to reflect
the discontinuation of the precision equipment business.

As a result of these decisions, and to streamline the Companys operations
and better support the commercialization of its emerging CPL semiconductor
manufacturing systems and related technologies, the Company now operates in
three business segments: the Research Division, the Systems Division and the
Microelectronics Division.

Results of Consolidated Operations

Total revenues for the three months ended September 30, 2003 and 2002 were
$3,964,930 and $6,462,633, respectively. The net loss for the three months
ended September 30, 2003 and 2002 was $(624,161) and $(2,836,656),
respectively. The loss from continuing operations for those same periods was
$(570,488) and $(1,515,357), respectively, while the loss from operations for
those same periods was $(309,640) and $(1,471,282), respectively.

Total revenues for the nine months ended September 30, 2003 and 2002 were
$13,726,298 and $14,656,910, respectively. The net loss for the nine months
ended September 30, 2003 and 2002 was $(2,868,002) and $(4,586,442),
respectively. The loss from continuing operations for those same periods was
$(1,667,512) and $(965,490), respectively, while the loss from operations for
those same periods was $(1,231,896) and $(1,707,381), respectively.

Included in the net loss for the three and nine months ended September 30,
2003 is a loss from discontinued operations of $(53,673) and $(1,200,490),
respectively. Included in the net loss and loss from operations for the nine
months ended September 30, 2003 is an asset writedown of $200,056. Included in
the net loss and loss from operations for the three and nine months ended
September 30, 2002 is a special item of $1,074,324 for charges recorded related
to the retirement benefits in August 2002 of the Companys Chairman and Chief
Executive Officer. Included in the net loss and loss from continuing operations
for the nine months ended September 30, 2002 is a gain on the sale of
marketable securities of $1,349,721. Also,
included in the net loss for the three and nine months ended September 30, 2002
is a loss from operations of discontinued operations of $(1,321,299) and
$(3,620,952), respectively, and, in the nine months ended September 30, 2002, a
deferred income tax expense of $484,423 resulting from an increase in the
valuation allowance against the Companys deferred tax assets.

The decrease in revenues for the three months ended September 30, 2003
compared to the three months ended September 30, 2002 was primarily
attributable to a decrease in revenues related to the DARPA contract of
$1,970,608 due to approximately $1.5 million in unfunded costs
that were incurred in the
quarter ended June 30, 2002, but were required to be recognized as revenue in the quarter
ended September 30, 2002 when the funding was received. In addition, there was
a decrease in other contract revenues of the Systems Division of $389,878.

The decrease in revenues for the nine months ended September 30, 2003
compared to the nine months ended September 30, 2002 was primarily attributable
to a decrease in revenues related to the DARPA contract of $2,861,261 due to
lower funding received on that contract. These decreases were offset in part by
an increase in contract revenues at the Microelectronics Division of
$1,476,604, related to the receipt of approximately $5 million in contracts
from General Dynamics Advanced Information Systems (GDAIS) in February 2003.
In May, 2002, the Systems Division received an approximately $10 million
contract from Naval Air Warfare Center AD for sub-100nm X-ray masks for Next
Generation Lithography Systems (the Navair Contract). For the nine months
ended September 30, 2003 compared to the nine months ended September 30, 2002,
there was an increase in the Navair Contract revenues of $853,000
offset by a decrease in other contract revenues of the Systems Division of
$229,360.

In
addition to $1 million in DARPA funding received in
November 2003 and another $1.6 million expected by December 31,
2003, the Company expects another $5.4 million in funding from DARPA in 2004.
The Company also expects additional funding of $2.4 million
under the Navair Contract and $1.5 million under the GDAIS
contract in 2004. In connection with the award of the Navair
Contract in 2002, the Company entered into a subcontract with IBM
to manufacture and deliver X-ray masks to JMAR.  In

18



---



##### Table of Contents



October 2003, the Company was notified
by IBM that it was discontinuing its Vermont x-ray lithography mask making operations
and terminating its
subcontract with the Company effective December 31, 2003 for the production of
masks under the Navair Contract. Following termination of the subcontract, the
Company believes it will have sufficient masks for its planned lithography exposure tests.
The Company has had discussions with another commercial mask supplier and believes that it
will enter into a subcontract with this supplier early in 2004 to
continue to provide masks under the expected $2.4 million funded
portion of the Navair Contract. The failure to redirect the Navair
Contract funding to an alternative mask supplier could result in a
shortfall in recognizing the full $2.4 million expected under the
Navair Contract in 2004.

Gross margins for the nine months ended September 30, 2003 and 2002 were
20.9% and 25.0%, respectively. Gross margins for the three months ended
September 30, 2003 and 2002 were 24.8% and 17.8%, respectively. The Companys
margins are low because the majority of its revenues are from government
contracts or subcontracts, which inherently generate lower margins than product
revenues. The decrease in the gross margin for the nine months in 2003 was due
to lower margins at the Systems Division related to non-DARPA contracts for the
nine months ended September 30, 2003 (6.3%) compared to 2002 (9.8%). This
reduction is related to the Navair Contract having lower margins due to its
high subcontract component, and the Companys absorption of most
of its overhead and general and administrative costs related to the
contract due to limited funding on that contract. In addition, the Company
started another contract later in 2002, which has low margins due to estimated
cost overruns on that contract. Also, gross margins on the Microelectronics
Division contract with GDAIS were lower for the nine months ended September 30,
2003 (18.2%) compared to 2002 (25.1%) due to a contract cost overrun of $70,000
in 2003 and a higher amount of material costs in 2003. The majority of
the Companys revenues in 2003 will be derived from government contracts or
subcontracts, so gross margins will continue at similar levels as they have
been for the first nine months of 2003. The increase in gross margins for the
three months in 2003 was due to a higher percentage utilization of direct
labor.

Selling, general and administrative (SG&A) expenses for the nine months
ended September 30, 2003 and 2002 were $3,499,933 and $3,711,490, respectively.
SG&A expenses for the three months ended September 30, 2003 and 2002 were
$1,116,762 and $1,343,624, respectively. The decrease in SG&A expenses for
2003 was primarily attributable to a reduction in SG&A costs of the Systems
Division due to
the elimination of several sales and marketing positions as a result of the
consolidation of the Companys sales and marketing activity with the hiring of
John Ricardi as Vice President of Business Development.

The asset writedown in 2003 of $200,056 relates to an asset held by the
Research Division that will not be used by the Company in the future. The
special item in 2002 is for charges related to the retirement in August 2002 of
the Companys Chairman and Chief Executive Officer.

The Companys research, development and engineering program (RD&E)
consists of two types: Customer-Funded RD&E (U.S. government and other
companies) and Company-Funded RD&E. Both types of RD&E costs are expensed when
incurred. Customer-Funded RD&E costs incurred, included in Costs of Sales,
totaled $2,208,948 and $4,363,671 for the three months ended September 30, 2003
and 2002, respectively, and $7,750,712 and $9,168,997 for the nine month
periods ended September 30, 2003 and 2002, respectively. The decrease in
Customer-Funded RD&E expenditures for the nine months ended September 30, 2003
is primarily related to a decrease in contract costs of $2,208,118 incurred
related to the DARPA contract offset in part by an increase in contract costs
of $774,497 related to the Navair Contract. Company-Funded RD&E costs are shown
in Operating Expenses and totaled $176,100 and $203,138 for the three months
ended September 30, 2003 and 2002, respectively, and $397,932 and $586,270 for
the nine months ended September 30, 2003 and 2002, respectively. Hence, total
RD&E expenditures for the three month periods were $2,385,048 and $4,566,809
for 2003 and 2002, respectively, and $8,148,644 and $9,755,267 for the nine
month periods in 2003 and 2002, respectively. Total RD&E expenditures as a
percentage of sales were 60.2% and 70.7% for the three months ended September
30, 2003 and 2002, respectively, and 59.4% and 66.6% for the nine months ended
September 30, 2003 and 2002, respectively. These expenditures are primarily
related to the continued development of collimated plasma lithography systems
for the semiconductor industry.

The loss from operations of discontinued operations of $258,673 and
$1,405,490, respectively, for the three and nine months ended September 30,
2003 includes $155,526 and $467,503, respectively, related to the standard
semiconductor products business and $103,147 and $937,987, respectively,

19



---



##### Table of Contents



related to the precision equipment business. The loss from operations of
discontinued operations of $1,321,299 and $3,620,952, respectively, for the
three and nine months ended September 30, 2002 includes $363,000 and
$1,548,861, respectively, related to the standard semiconductor products
business and $958,299 and $2,072,091, respectively, related to the precision
equipment business. In July 2003, the Company sold JMAR Precision
Systems, Inc. (JPSI) to several private
investors. Under the terms of the sale, JMAR received $500,000 in a
combination of cash and promissory notes, and the buyer assumed 14 of the
remaining 25 months of JPSIs facility lease. The notes are secured by the
assets of JPSI and the lease obligation is secured by personal property of the
buyers. In addition, all JPSI receivables as of the closing were assigned to
JMAR and JMAR agreed to pay all trade and employee related liabilities existing
as of the closing and unknown liabilities, if any. The buyers have assumed all
other ongoing commitments of JPSI. The results of operations of the precision
equipment business for 2003 through the sale date are reported in discontinued
operations in 2003. The decrease in the loss of operations of discontinued
operations is primarily due to the shutdown of the operations of
JMAR Semiconductor, Inc. (JSI) in 2002 and the sale of
JPSI in July 2003.
The gain on disposal of discontinued operations of $205,000 for the three and
nine months ended September 30, 2003 relates to the sale of JPSI.

In
September 2000, JSI moved into a
significantly larger facility in anticipation of realizing its growth plans.
Prior to December 31, 2001, the Company decided to take action to sublease the
facility and move JSI into a smaller facility. The Company does not yet have a
subtenant for this facility and, as of September 30, 2003, the Company has
approximately $577,000 accrued for estimated future losses under this lease.
The lease provides for rent and related expenses of approximately $36,000 per
month through August 2005.

The gain on sale of marketable securities of $1,349,721 for 2002 is
related to the sale of the Companys remaining 545,500 shares of its investment
in Bede plc (Bede) in January 2002.

Interest and other expense for the three months ended September 30, 2003
and 2002 was $264,649 and $46,640, respectively, and for the nine months ended
September 30, 2003 and 2002 was $495,475 and $153,061, respectively. Interest
and other expense are higher for 2003 versus 2002 primarily due to the
financing transactions the Company entered into in 2003 (see Consolidated
Liquidity and Financial Condition below). Included in interest expense for the
three and nine months ended September 30, 2003 is $180,826 and $187,935,
respectively, related to the beneficial conversion feature associated
with the securities issued in these financing transactions. Also, interest
expense for the nine months ended September 30, 2003 and 2002 includes $132,988
and $48,159, respectively, related to the amount accrued for the retirement in
August 2002 of the Companys former Chairman and Chief Executive Officer.

Included in the loss applicable to common stock in the Statement of
Operations for the three and nine months ended September 30, 2003 is preferred
stock dividends of $439,290 and $668,743, respectively. The amount for the
three and nine months ended September 30, 2003 represents $12,509 and $40,113,
respectively, of dividends paid in cash and $426,781 and $628,630,
respectively, related to the beneficial conversion feature.

Results of Segment Operations

The results of segment operations (excluding corporate costs allocable to
discontinued operations) for the three and nine months ending September 30,
2003 and 2002 are as follows:

|                          |  |                                  |           |                         |  |      |           |      |  |   |          |   |  |   |          |  
|------------------------- |  | -------------------------------- | --------- | ----------------------- |  | ---- | --------- | ---- |  | - | -------- | - |  | - | -------- | -
|                          |  | Three Months Ended September 30,
|                          |  |                                 
|                          |  | Revenues                         |           | Operating Income (Loss)
|                          |  |                                  |           |                        
|                          |  | 2003                             |           | 2002                    |  | 2003 |           | 2002
|                          |  |                                  |           |                         |  |      |           |     
|Research Division         |  | $                                | 1,440,942 |                         |  | $    | 3,294,434 |      |  | $ | 62,952   |   |  | $ | 203,390  |  
|Systems Division          |  |                                  | 1,520,045 |                         |  |      | 2,140,867 |      |  |   | (377,130 | ) |  |   | (301,869 | )
|Microelectronics Division |  |                                  | 1,003,943 |                         |  |      | 1,027,332 |      |  |   | 54,223   |   |  |   | 36,351   |  
|                          |  |                                  |           |                         |  |      |           |      |  |   |          |   |  |   |          |  
|                          |  | $                                | 3,964,930 |                         |  | $    | 6,462,633 |      |  | $ | (259,955 | ) |  | $ | (62,128  | )
|                          |  |                                  |           |                         |  |      |           |      |  |   |          |   |  |   |          |  

20



---



##### Table of Contents



|                          |  |                                 |            |                         |  |      |            |      |  |   |            |   |  |   |          |  
|------------------------- |  | ------------------------------- | ---------- | ----------------------- |  | ---- | ---------- | ---- |  | - | ---------- | - |  | - | -------- | -
|                          |  | Nine Months Ended September 30,
|                          |  |                                
|                          |  | Revenues                        |            | Operating Income (Loss)
|                          |  |                                 |            |                        
|                          |  | 2003                            |            | 2002                    |  | 2003 |            | 2002
|                          |  |                                 |            |                         |  |      |            |     
|Research Division         |  | $                               | 4,494,234  |                         |  | $    | 5,418,556  |      |  | $ | 65,849     |   |  | $ | 397,401  |  
|Systems Division          |  |                                 | 5,619,409  |                         |  |      | 7,007,957  |      |  |   | (1,189,193 | ) |  |   | (444,725 | )
|Microelectronics Division |  |                                 | 3,612,655  |                         |  |      | 2,230,397  |      |  |   | 159,016    |   |  |   | 290,001  |  
|                          |  |                                 |            |                         |  |      |            |      |  |   |            |   |  |   |          |  
|                          |  | $                               | 13,726,298 |                         |  | $    | 14,656,910 |      |  | $ | (964,328   | ) |  | $ | 242,677  |  
|                          |  |                                 |            |                         |  |      |            |      |  |   |            |   |  |   |          |  

The $1,853,492 decrease in revenues for the Research Division for the
three months ended September 30, 2003 as compared to the three months ended
September 30, 2002 is primarily due to approximately $1.5 million in unfunded
costs incurred related to its lithography work for DARPA in the quarter ended
June 30, 2002, which were recognized as revenue in the quarter ended September
30, 2002 when the funding was received. The additional decrease for the three
month period as well as the decrease of $924,322 for the nine months ended
September 30, 2003 as compared to the nine months ended September 30, 2002 is
primarily due to lower funding received on the DARPA contract. The
$331,552 decrease in the operating income for the nine month period of the Research Division is
primarily due to an asset writedown of $200,056 and the lower
revenues.

The $620,822 decrease in revenues for the Systems Division for the three
months ended September 30, 2003 as compared to the three months ended September
30, 2002 and the $1,388,548 decrease in revenues for the nine months ended
September 30, 2003 as compared to the nine months ended September 30, 2002 is
primarily due to lower revenues related to the DARPA contract. In
addition, there was a decrease in other contract revenues of the
Systems Division of $389,878 and $229,360 for the three and nine
months ended September 30, 2003 compared to the corresponding
periods in 2002. For the nine months ended September 30, 2003
compared to the nine months ended September 30, 2002, these
decreases were offset in part by an increase in the Navair Contract revenues of $853,000. In addition to
the lower revenues in 2003, the $75,261 and $744,468 increase in the operating
loss of the Systems Division for the three and
nine months ended September 30, 2003 as compared to the three and nine months
ended September 30, 2002 is due to a decrease in the gross margin in 2003
primarily due to the Navair Contract having lower margins due to its high
subcontract component, and the Companys absorption of most of its overhead and
general and administrative costs related to the contract due to the limited
funding on that contract. In addition, the Systems Division started another
contract later in 2002, which has low margins due to estimated cost overruns on
that contract. Due to these losses, in July 2003 the Systems Division reduced
its headcount by 20 percent. Several sales and marketing positions at the
Systems Division were eliminated as a result of the consolidation of the sales
and marketing activity with the hiring of John Ricardi as Vice President of
Business Development. The balance of the reductions were for positions deemed
not critical to the ongoing CPL commercialization effort. Because of the
continued losses of the Systems Division, the Company is considering other cost
cutting actions.

The increase in revenues of $1,382,258 for the Microelectronics Division
for the nine months ended September 30, 2003 as compared to the nine months
ended September 30, 2002 is due to the receipt of approximately $5 million in
additional contracts in February, 2003 from General Dynamics Advanced
Information Systems to enhance the semiconductor wafer fabrication processes
installed at the foundry at McClellan Air Force Base in Sacramento owned by the
Defense Microelectronics Agency. The decrease in the operating income of
$130,985 of the Microelectronics Division for the nine months ended September
30, 2003 as compared to the nine months ended September 30, 2002 despite the
higher revenues is primarily due to lower margins in 2003 due to a contract
cost overrun of approximately $70,000 in 2003, and a higher allocation
of corporate costs in 2003.

Consolidated Liquidity and Financial Condition

Unrestricted cash and cash equivalents at September 30, 2003 was
$2,193,778. The decrease in unrestricted cash and cash equivalents during the
nine months ended September 30, 2003 of $52,486 resulted primarily from cash
used in continuing operations of $2,508,684 primarily related to operating
losses and a reduction in liabilities, cash used in discontinued operations of
$1,443,567 and a net decrease in line of credit borrowings of $1,449,146 offset
by proceeds from the issuance of preferred and common stock of $4,239,300 and
the conversion of $1,360,296 of restricted cash to unrestricted cash.

JMARs operations will continue
to use cash in 2003 and
into 2004 for, among other requirements, 1) certain CPL commercialization costs
not covered by existing contracts; 2) temporary funding delays related to
government contracts; and 3) corporate costs, primarily related to the cost of

21



---



##### Table of Contents



being a public company. Working capital (deficit) as of September 30, 2003 and
December 31, 2002 was $173,573 and $(780,117), respectively. The increase in
working capital is primarily due to proceeds received from the issuance of
preferred stock of $3.5 million and the conversion into common stock of
$897,000 of the Companys line of credit offset in part by the classification
as a current liability as of September 30, 2003 of $1.2 million in notes to the
former SAL noteholders due February 2004 and the Companys losses. The Company
has had discussions with the representative of the SAL noteholders regarding
the extinguishment of this debt with stock or otherwise amending the terms of
the debt. However, there can be no assurance that the terms of this debt will
be amended.

In March 2003, the Company entered into a Revolving Fixed Price
Convertible Note (the Working Capital Line) with Laurus Master Fund
(Laurus). The Working Capital Line allows the Company to borrow from
time-to-time up to 85% of eligible accounts receivable of the Company to a
maximum of $3 million. Advances in excess of this formula are allowed,
however, with the consent of Laurus. The Company can convert a portion of the principal
outstanding to common stock at $.92 per share (the Conversion Price) if the
market price of the Companys common stock averages 118% of the Conversion
Price or higher for 22 consecutive trading days. Laurus can convert any
portion of the principal outstanding to common stock at the Conversion Price
any time the market price of the Companys common stock is in excess of the
Conversion Price. After the first $2 million of conversions into equity, the
Conversion Price will be adjusted upward. The interest rate on the Working
Capital Line is prime (4% at September 30, 2003) plus .75 percent, subject to a
floor of 5 percent. Accrued interest is payable monthly. The Working Capital
Line
requires that the Companys quick ratio, as defined, be .90 or higher. Quick ratio is defined as
the sum of cash and accounts receivable divided by the sum of current
liabilities, exclusive of current liabilities of assets held for sale. The
Companys quick ratio was 1.15 at September 30, 2003. As of
September 30, 2003, approximately $100,000 was outstanding under the Working
Capital Line. The term of the Working Capital Line runs until March,
2006. The available borrowings under the Working Capital Line were
approximately $2 million at September 30, 2003.

In March
2003, the Company sold for cash $1 million in shares of 8 percent Series
A Convertible Preferred (the Series A Preferred) to Laurus at a fixed
conversion price of $.88 per share. Accrued dividends are payable monthly.
The Series A Preferred must be redeemed in two years, if not previously
converted. Except for the conversion price, the conversion terms of the Series
A Preferred are the same as the conversion terms of the Working Capital Line.
The proceeds received under the Series A Preferred are initially restricted,
however, the funds are released as the Preferred Stock is converted to common
stock. For the nine months ended September 30, 2003, Laurus converted $780,296
of the Series A Preferred into 886,700 shares of common stock of the Company.

In
addition, in March 2003, the Company also sold for cash $1 million in shares
of 3 percent Series B Convertible Preferred Stock (the Series B Preferred) to
Laurus at a fixed conversion price of $.88 per share. Accrued dividends are
payable monthly. Principal is payable in cash or stock in twelve equal monthly
installments starting October 1, 2003. Except for the conversion price, the
conversion terms of the Series B Preferred Stock are the same as the conversion
terms of the Working Capital Line. Conversions to equity are offset against
the required principal repayments and, as a result of conversion to
date, the
first installment payment is scheduled for June, 2004. For the nine months
ended September 30, 2003, Laurus converted $691,504 of the Series B Preferred
into 785,800 shares of common stock of the Company.

In connection with all of the above financing transactions with Laurus,
the Company issued to Laurus warrants to purchase 550,000 shares of common
stock at prices ranging from $1.058 to $1.33. In addition, Laurus will be
issued a warrant to purchase one share of common stock for every $20 of
principal of the Working Capital Line converted to equity, up to a total of
150,000 shares, at an exercise price of $1.15 per share.

In September 2003, the Company sold for cash $1.5 million of 8 percent
Series C Convertible Preferred Stock (Series C Preferred) to Laurus at a
fixed conversion price of $2.08 per share. The Series C Preferred is
redeemable in cash or stock (if the closing market price of the Companys
common stock is 118% of the Conversion Price or higher for the 11 trading days
prior to the redemption date) in twelve equal monthly installments starting in
April, 2004, if not previously converted. Conversions to equity

22



---



##### Table of Contents



are offset
against the required repayments. Except for the conversion price, the
conversion terms of the Series C Preferred are the same as the conversion terms
of the Working Capital Line.

In
connection with the September 2003 financing, the Company issued to Laurus warrants
to purchase 150,000 shares of common stock at an exercise price of $2.60. The
Company valued these warrants using the Black-Scholes model and recorded the
fair value of $201,000 as a discount to the preferred stock. In addition, the
Company recorded an additional discount of $201,000 representing the intrinsic
value of the beneficial conversion feature for the convertible preferred stock,
which will be amortized over the redemption period of the preferred stock using
the effective interest method.

In February, 2003, under its Shelf Registration Statement, the Company
sold 100,000 shares of its Common Stock and a Warrant for 20,000 shares,
exercisable at $1.25 per share, for gross proceeds of $100,000. The Series A
and B Convertible Preferred Stock and 300,000 of the Warrants described above
were also sold under the Universal Blank Shelf Registration Statement.

In September 2002, All American Semiconductor, Inc. (All
American) filed a Complaint against JSI and JMAR seeking payment
of approximately $700,000 owed by JSI to All American. In September
2003, the Company and All American executed a settlement agreement
whereby the Company agreed to pay All American $500,000 in full
satisfaction of all amounts owed to All American. The settlement amount
was paid by the Company in October 2003.

Management believes that, including the above financings, the Company has
adequate resources to fund operations and working capital requirements through
September 30, 2004 except for $1.2 million in debt due in February, 2004 to the
former creditors of SAL, Inc., which the Company acquired in August, 2001. The
Company has had discussions with the representative of the noteholders of this
debt regarding the
extinguishment of this debt with stock or otherwise amending the terms of
the debt. If the Company is unsuccessful in its negotiations with the
noteholders, it will need to raise additional financing to retire this
debt. In November 2003, the Company received $1 million in
funding under its DARPA contract and is expecting additional funding of $1.6 million before
December 31, 2003, the receipt of which is based on
certain milestones. If this funding is not received, the Company may need to
obtain financing to continue this work. The Company expects to receive
approximately $5.4 million in additional funding under its DARPA contract for
2004. Because of normal delays in the release of such funding, in the first
quarter of 2004, the Company expects a delay in receipt of these funds
which may require the Company to obtain financing for the costs incurred on this contract prior to the
receipt of funds. In addition, the Company has determined that it will require
additional financing to complete or accelerate the development of some of its
high value emerging new products, including its patented CPL systems for the
manufacture of high-performance semiconductors. There can be no assurance that
additional financings will be available when needed, or if available,
will be done on favorable terms.

The Companys stockholders equity was $3,875,534 as of September 30,
2003. The Company transferred to the Nasdaq SmallCap Market on May 9, 2003,
where it is required to maintain no less than $2.5 million of stockholders
equity to retain its listing. Continued losses without increases in equity
would cause the Company to fall below this NASDAQ requirement, which would
require it to come into compliance or face delisting. The delisting of the
Companys stock could adversely affect its ability to raise funds in the
future. The Company believes that it has available to it several potential
sources of capital to meet NASDAQ listing standards, particularly the above
described financings. The Company is also pursuing opportunities for strategic
relationships with semiconductor industry partners, one of the goals of which
would involve receipt of additional funding, in order to accelerate the
commercialization of its emerging CPL products.

On August 7, 2001, the Companys wholly owned subsidiary, JMAR/SAL
NanoLithography, Inc. (Subsidiary) acquired (the Acquisition) all of the
outstanding equity of Semiconductor Advanced Lithography, Inc. (SAL), in a
merger of SAL with and into Subsidiary (Merger). Consideration for the
Merger consisted of an aggregate of 603,051 shares of the Companys common
stock, $1.2 million in cash and $1.2 million in notes (the SAL Notes). The
SAL Notes are convertible into shares of the Companys common stock at a price
of $4.302. The SAL Notes are convertible by the holders at any time and the
Company can force conversion if the average price, as defined, of the Companys
common stock during any ten-day trading period exceeds $6.45. Interest on the
SAL Notes is payable quarterly, with the entire principal amount due, if not
converted, on February 7, 2004. The resale by the holders of the conversion
shares is covered by an effective registration statement. As discussed above,
the Company is pursuing the extinguishment of the SAL Notes with common stock
of the Company, or otherwise amending the Notes.

23



---



##### Table of Contents



Under the Merger Agreement, SALs former shareholders and creditors could
earn up to three contingent earnout payments upon the satisfaction of three
earnout conditions. For the first earnout, the SAL creditors were eligible to
receive $500,000 in Convertible Notes upon the satisfaction of a stepper
limited throughput test (without the CPL light source) by June 30, 2002.
This requirement was not met by the June 30, 2002 deadline, and,
therefore, the Company did not have to issue the $500,000 in Convertible Notes.
For the second earnout, the SAL shareholders can earn $500,000 in Convertible
Notes upon the satisfaction of a lithography demonstration milestone. This
milestone must be met 90 days after the CPL light source is integrated with the
stepper at the Systems Division in Vermont and has satisfied certain negotiated
source performance criteria. The specific source performance criteria specified
in the Merger Agreement have not been met by the currently integrated source
because of unstable power output and low reliability, so the 90 day period to
satisfy this milestone has not yet commenced. A second beta source is under development by the Research Division and is
intended to have both the reliability and X-ray power needed to start the
second earnout period in 2004.

The third earnout condition can result in
payment of up to 354,736 JMAR shares and up to $1.2 million in Convertible
Notes upon receipt by the Company of a qualifying order for a CPL system from a
commercial customer and delivery to the customer. Under the Merger Agreement,
the deadline for receipt of this order is 180 days after the CPL source is
integrated with the stepper at the Systems Division in Vermont and has
satisfied the
above-mentioned source performance criteria. If earned, this earnout
payment is payable 30 days after delivery and acceptance of the system by the
customer.

Commitments

Future minimum annual commitments under bank and other debt agreements,
non-cancellable operating leases (net of subleases) and post-employment
benefits as of September 30, 2003 are as follows (unaudited):

|                         |  |      |           |      |  |      |         |      |  |            |         |       |  |   |         |  |  |   |         |  |  |   |           | 
|------------------------ |  | ---- | --------- | ---- |  | ---- | ------- | ---- |  | ---------- | ------- | ----- |  | - | ------- |  |  | - | ------- |  |  | - | --------- | 
|                         |  | 2004 |           | 2005 |  | 2006 |         | 2007 |  | Thereafter |         | Total
|                         |  |      |           |      |  |      |         |      |  |            |         |      
|Bank and other
debt      |  | $    | 1,200,000 |      |  | $    |        |      |  | $          |        |       |  | $ |        |  |  | $ |        |  |  | $ | 1,200,000 | 
|Operating leases         |  |      | 826,854   |      |  |      | 496,277 |      |  |            | 39,970  |       |  |   |        |  |  |   |        |  |  |   | 1,363,101 | 
|Post-employment
benefits |  |      | 211,172   |      |  |      | 211,172 |      |  |            | 211,172 |       |  |   | 211,172 |  |  |   | 138,074 |  |  |   | 982,762   | 
|                         |  |      |           |      |  |      |         |      |  |            |         |       |  |   |         |  |  |   |         |  |  |   |           | 
|                         |  | $    | 2,238,026 |      |  | $    | 707,449 |      |  | $          | 251,142 |       |  | $ | 211,172 |  |  | $ | 138,074 |  |  | $ | 3,545,863 | 
|                         |  |      |           |      |  |      |         |      |  |            |         |       |  |   |         |  |  |   |         |  |  |   |           | 

Excluded from the above table is Series A, B and C Preferred Stock in the
gross amount of approximately $2 million at September 30,
2003. The Series B Preferred Stock in the amount of
$308,496 at September 30, 2003 is redeemable, if not previously converted, in
twelve equal monthly payments starting June 2004, the Series A Preferred Stock
is redeemable, if not previously converted, in March 2005 and the Series C
Preferred Stock is redeemable, if not previously converted, in eighteen equal
monthly payments starting in April 2004 (see page 22). Also excluded from the
above table is the Companys $3 million Working Capital Line. The Working
Capital Line balance was approximately $100,000 at September 30, 2003.

As noted above, pursuant to the acquisition of SAL, its former
shareholders and creditors can earn up to two earnout payments upon the
satisfaction of certain earnout conditions.

At December 31, 2002, the Company had approximately $44 million of Federal
net operating loss carryforwards subject to certain annual limitations, which
expire from 2004 through 2022. To the extent the Company has taxable income in
the future, these carryforwards may be used by the Company to reduce its cash
outlay for taxes.

24



---



##### Table of Contents



Critical Accounting Policies and Estimates

Managements Discussion and Analysis of Financial Condition and Results of
Operations discusses JMARs consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period.

On an ongoing basis, management evaluates its estimates and judgments,
including those related to revenues, allowances for doubtful accounts,
inventory reserves, goodwill and intangible assets, deferred taxes, litigation
accrual, warranty reserve and stock based compensation. Management bases its
estimates and judgments on historical experience and on various other factors
that are believed to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions. Management believes the following critical accounting
policies, among others, affect its more significant judgments and
estimates used in the preparation of its consolidated financial statements.

Revenues

Product revenues are recognized when the product is shipped FOB shipping
point, all risks of ownership have passed to the customer and the Company has
performed all obligations in accordance with Staff Accounting Bulletin No 101,
Revenue Recognition in Financial Statements (SAB No. 101).

Contract revenues are recognized based on the percentage of completion
method wherein income is recognized pro-rata over the life of the contract
based on the ratio of total incurred costs to anticipated total costs of the
contract. The program manager prepares a statement of work, schedule and
budget for each contract. At least monthly, actual costs are compared to budget
and technical progress is compared to the planned schedule. The Company
prepares an estimate of costs to complete for each contract at least quarterly.
Estimated losses based on this review, if any, are fully charged to operations
when identified. Actual costs could differ from these estimated costs.

Allowances for Doubtful Accounts

JMAR maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. If the
financial condition of JMARs customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
required. Management reviews delinquent accounts at least quarterly to identify
potential doubtful accounts, and together with customer follow-up estimates the
amount of potential losses. Historically, the Companys losses from bad debts
have been minimal.

Inventory Reserves

At each year-end, the Company prepares a report which indicates the date
that each inventory part was last used. Any inventory parts that have not been
used in the past two years are isolated and reviewed for possible excess and/or
obsolescence based on current and future requirements. The inventory reserve
is adjusted based upon that review. In addition, any known excess and/or
obsolete inventory not meeting the above requirement is evaluated for inclusion
in the reserve. Obsolete inventory is disposed of after a thorough
investigation. Quarterly, any known excess and/or obsolete inventory based on
changes in the business or other factors are evaluated and the reserve adjusted
accordingly.

Goodwill and Intangible Assets

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets,
effective January 1, 2002, the Company has established reporting units and
applies a two-step fair value approach to

25



---



##### Table of Contents



evaluating goodwill impairment, using
at least an annual assessment. The Company compares the fair value of the
business unit with the carrying amount of the assets associated with the
business unit. The fair value of each business unit is determined using a risk
adjusted discount rate to compute a net present value of estimated future cash
flows and a consideration of market capitalization of the Company. The second
step measures the amount of the impairment, if any.

Deferred Taxes

JMAR records a valuation allowance to reduce its deferred tax assets to
the amount that management believes is more likely than not to be realized in
the foreseeable future, based on estimates of foreseeable future taxable income
and taking into consideration historical operating information. In the event
management estimates that it will not be able to realize all or part of its net
deferred tax assets in the foreseeable future, a valuation allowance is
recorded through a charge to income in the period such determination is made.
Likewise, should management estimate that it will be able to realize its
deferred tax
assets in the future in excess of its net recorded asset, an adjustment to
reduce the valuation allowance would increase income in the period such
determination is made.

Litigation Accrual

Estimated amounts for litigation reserves that are probable and can be
reasonably estimated are recorded as liabilities. Estimates are based upon the
facts and circumstances of each case and, in part, on advice from legal counsel
regarding probable outcomes, if determinable. Management reviews its estimates
on a quarterly basis.

Warranty Reserve

The Company records a warranty reserve based on 1% of product sales.
Warranty costs are offset against the reserve. Each quarter the reserve is
analyzed based on actual warranty costs incurred to ensure that the reserve is
adequate for estimated future warranty activity.

Stock-Based Compensation Plans

The Company accounts for its stock option and warrant plans under APB
Opinion No. 25, using the intrinsic value method, under which no compensation
cost has been recognized for issuances to employees. Options and Warrants
issued to non-employees (other than directors) are accounted for based on the
fair value of the equity instrument issued. The fair value is determined based
on the Black-Scholes method. The resulting value is amortized over the service
period.

Safe Harbor Statement under the Private Securities Litigation Reform Act of
1995

Certain statements contained in this Form 10-Q which are not related to
historical results, including statements regarding JMARs future sales or
profit growth, competitive position or products, projects or processes
currently under development, the ability of the Company to successfully
introduce those products into the commercial marketplace or to apply those
products, projects or processes to alternative applications and the
availability of future bank or equity investor financing are forward-looking
statements that necessarily are based on certain assumptions and are subject to
certain risks and uncertainties that could cause actual future performance and
results to differ materially from those stated or implied in the
forward-looking statements. These risks and uncertainties include the lack of
funds to continue development and commercialization of our CPL products due to
delays in funding of government contracts and delays in securing, or inability
to secure, other financing, whether from the public or private debt or equity
markets or from commercial lenders or otherwise. Other risks include the
Companys failure to achieve levels of power and reliability in its CPL source
that are required by customers, the failure of the GaAs chip market to recover
and grow, delays in shipments or cancellations of orders, failure of expected
orders to materialize, fluctuations in margins, or the failure to lower
manufacturing costs sufficiently to achieve acceptable margins, lack of
availability of critical components, the failure of pending patents to be
issued, delays in development, introduction and acceptance of new products,
changing business and

26



---



##### Table of Contents



economic conditions in various geographic regions,
technical problems in the development or modification of its CPL or EUV
sources, the impact of competitive products and pricing, including the risk
that current lithography technologies can continue to economically produce
smaller feature sizes or that the EUV LLC is successful in developing an
acceptable next generation lithography process that becomes the process of
choice for the semiconductor industry or that the semiconductor industry fails
to adopt CPL as the lithography alternative, the degree of success of
technology transfer (e.g., advanced lithography sources, etc.) to commercial
products, availability of working capital to support growth, continued
government funding of advanced lithography, successful integration of
acquisitions, declining credit markets, the non-payment of the deferred
purchase price received in the sale of JPSI, greater JPSI liabilities assumed
than estimated, other competitive factors and temporary cessation of operations
at one or more of its division facilities due to natural events such as floods,
earthquakes and fires, and other risks detailed in the Companys Form 10-K
for the year ended December 31, 2002, and in the Companys other filings
with the Securities and Exchange Commission.




Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The Companys exposure to interest rate risk is minimal due to the
relatively small amount of investments and variable rate debt. The Company has
no investments in derivative financial instruments.




Item 4. Controls and Procedures.

The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in the Companys Exchange
Act reports is recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms, and that such information is
accumulated and communicated to the Companys management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure. In designing and evaluating the
disclosure controls and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and
management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.

The Company carried out an evaluation, under the supervision and with the
participation of the Companys management, including the Companys Chief
Executive Officer and the Companys Chief Financial Officer, of the
effectiveness as of September 30, 2003 of the design and operation of the
Companys disclosure controls and procedures (as defined in
Exchange Act Rule 13a-15(e)). Based on such evaluation, the
Companys Chief Executive Officer and Chief Financial Officer concluded that
the Companys disclosure controls and procedures were effective
in timely alerting them to material information required to be
included in the Company's reports filed or submitted under the
Exchange Act of 1934.

There have been no significant changes in the Companys internal control
over financial reporting during the last fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Companys internal
control over financial reporting.




PART II  OTHER INFORMATION




Item 1. Legal Proceedings.

All American Lawsuit

Following the discontinuance of the standard semiconductor products
business of JMAR Semiconductor, Inc. (JSI) in the first quarter of 2002, JSI
sought to negotiate debt reductions from the creditors associated with the
discontinued portion of its business. Among the debts of JSI was a debt of
approximately $700,000 to its distributor, All American Semiconductor, Inc.
(All American). Although the Company asserts that the debts of JSI are the
sole obligation of JSI and not of the Company, the Company is required to
reflect the liabilities of this subsidiary in its Consolidated
Balance Sheet and the Company has previously reflected approximately $700,000
owing to All American as a liability on its Consolidated Balance Sheet. In
September, 2002, All American filed a Complaint against JSI and

27



---



##### Table of Contents



JMAR in San
Diego Superior Court seeking payment of the $700,000 debt and other
damages. All American
alleged that JMAR was the alter ego of JSI and based on that theory should be
held responsible for the obligations of JSI. In September 2003, the Company
and All American executed a settlement agreement whereby the Company agreed to
pay All American $500,000 in full satisfaction of all amounts owed to All
American. The lawsuit was dismissed with prejudice in October, 2003.

Macrotech Lawsuit

Among the remaining liabilities of JSI included on the Companys
Consolidated Balance Sheet is a debt of approximately $200,000 owing to
Macrotech, Inc., a former supplier of chip manufacturing services to JSI. This
debt arises out of several purchase orders for FIFO chip manufacturing issued
by JSI to Macrotech. JSI claims that these purchase orders were cancelable as
to amounts that had not yet been confirmed for production and that JSI timely
canceled all but approximately $200,000 of the remaining obligations under
those purchase orders. In October, 2003, Macrotech
filed a Complaint against JSI alleging breach of contract and other related
claims and seeking payment of approximately $680,000, as well as punitive
damages in an unspecified amount. Macrotech also alleges that the Company is
the alter ego of JSI and should be held responsible for JSIs debts. JSI and
the Company deny that Macrotech is owed more than approximately $200,000 and
the Company asserts that it is not JSIs alter ego and is not responsible for
the debts of JSI. Although the Company believes the parties will continue to
engage in discussions in an effort to avoid the costs of litigation and to
reach a mutual resolution of this matter, if the lawsuit is pursued by Macrotech the Company
intends to vigorously defend this lawsuit.




Item 2. Changes in Securities.



| |                                                                                                                                                                                                                                                                                                                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (c)(i) In September, 2003, the Company issued $1.5 million of Series C
Convertible Preferred Stock (Series C Preferred) to Laurus Master Fund
Ltd. (Laurus). The Series C Preferred has a fixed conversion price of
$2.08 per share. Also issued in this transaction were Warrants to
purchase 150,000 shares of Common Stock at a price of $2.60 per share.
These issuances were exempt under Section 4(2) of the Act.
|
| | (c)(ii) In July, 2003, the Company granted warrants
to purchase 50,000 shares to Dian Griesel, President of The Investor
Relations Group, as compensation for investor and public relations
services. This transaction was exempt under Section 4(2) of the
Act.                                                                                                                                                           




Item 6. Exhibits and Reports on Form 8-K.



| |              
| | -------------
| | (a)  Exhibits



| |                                                                                                           
| | ----------------------------------------------------------------------------------------------------------
| | Exhibit 31.1 Certificate of Ronald A. Walrod pursuant to section
302 of the Sarbanes-Oxley Act of 2002.   
|
| | Exhibit 31.2 Certificate of Dennis E. Valentine pursuant to section
302 of the Sarbanes-Oxley Act of 2002.
|
| | Exhibit 32.1 Certificate pursuant to section 906 of the
Sarbanes-Oxley Act of 2002.                       



| |                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------
| | (b)   Reports on Form 8-K                                                                                                                          
|
| | The Company filed a Report on Form 8-K on August 18, 2003 related to the
announcement of its financial results for the quarter ended June 30,
2003.
|
| | The Company filed a Report on Form 8-K on July 31, 2003 related to the
sale of JMAR Precision Systems, Inc., a wholly-owned subsidiary.            

28



---



##### Table of Contents






SIGNATURE

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.

|                  |  |      |  |                                                                 
|----------------- |  | ---- |  | ----------------------------------------------------------------
|                  |  |      |  | JMAR TECHNOLOGIES, INC.                                         
|                  |  |      |  |                                                                 
|November 12, 2003 |  |      |  |                                                                 
|                  |  |      |  |                                                                 
|                  |  | By : |  | /s/ Ronald A. Walrod                                            
|                  |  |      |  |                                                                 
|                  |  |      |  | Ronald A. Walrod, Chief Executive Officer
and Authorized Officer
|                  |  |      |  |                                                                 
|                  |  | By : |  | /s/ Dennis E. Valentine                                         
|                  |  |      |  |                                                                 
|                  |  |      |  | Dennis E. Valentine, Chief Accounting Officer                   

29