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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 June 30, 2004
Commission File Number 1-10515 JMAR TECHNOLOGIES, INC. 
  Delaware
    
    68-0131180(State or other jurisdiction of
    
    (I.R.S. employerincorporation or organization)
    
    identification number)
 5800 Armada Drive
Carlsbad, CA 92008
(760) 602-3292  
 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 (August 9, 2004). Common Stock, $.01 par value: 30,891,787 shares




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INDEX Page #PART I. FINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated Balance Sheets  June 30, 2004 (unaudited) and December 31, 2003
    
    
    2Consolidated Statements of Operations (unaudited)  Three months and six months ended June 30, 2004 and 2003
    
    
    3Consolidated Statements of Cash Flows (unaudited)  Six months ended June 30, 2004 and 2003
    
    
    4Notes to Consolidated Financial Statements (unaudited)
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    25Item 4. Controls and Procedures
    
    
    25PART II. OTHER INFORMATIONItem 1. N/AItem 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    26Item 3. N/AItem 4. Submission of Matters to a Vote of Security Holders
    
    
    26Item 5. N/AItem 6. Exhibits and Reports on Form 8-K
    
    
    26EXHIBIT 10.1EXHIBIT 10.2EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
 1




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PART I  FINANCIAL INFORMATION JMAR TECHNOLOGIES, INC. 
 CONSOLIDATED BALANCE SHEETS
 As of June 30, 2004 and December 31, 2003
 June 30, 2004
    
    December 31, 2003(Unaudited)ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    8,737,301
    
    
    $
    4,171,179Accounts receivable, net
    
    
    4,584,117
    
    
    
    2,802,025Inventories
    
    
    264,011
    
    
    
    307,152Prepaid expenses and other
    
    
    1,010,799
    
    
    
    695,170Total current assets
    
    
    14,596,228
    
    
    
    7,975,526Property and equipment, net
    
    
    721,287
    
    
    
    791,773Intangible assets, net
    
    
    592,656
    
    
    
    684,041Other assets
    
    
    297,832
    
    
    
    250,936Goodwill, net
    
    
    3,790,907
    
    
    
    3,790,907TOTAL ASSETS
    
    $
    19,998,910
    
    
    $
    13,493,183LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    632,507
    
    
    $
    1,102,873Accrued liabilities
    
    
    874,547
    
    
    
    561,716Accrued payroll and related costs
    
    
    612,297
    
    
    
    582,357Line of credit and notes payable, net of discount
    
    
    
    
    
    
    2,340,431Current liabilities of discontinued operations, including notes payable
    
    
    400,638
    
    
    
    960,983Total current liabilities
    
    
    2,519,989
    
    
    
    5,548,360Notes payable and other long-term liabilities, net of current portion
    
    
    479,599
    
    
    
    449,873Redeemable convertible preferred stock, 950,000 shares issued and outstanding
as of June 30, 2004 and 350,000 shares as of December 31, 2003
    
    
    8,178,812
    
    
    
    2,217,150Stockholders equity:Preferred stock, $.01 par value; 5,000,000 shares authorized; 950,000
shares issued and outstanding as of June 30, 2004 included in redeemable
convertible preferred stock above, and 350,000 issued and outstanding as of
December 31, 2003
    
    
    
    
    
    
    Common stock, $.01 par value; 40,000,000 shares authorized; Issued and
outstanding 30,891,787 shares as of June 30, 2004 and 27,654,845 shares as of
December 31, 2003
    
    
    308,918
    
    
    
    276,548Additional-paid in capital
    
    
    69,376,434
    
    
    
    62,420,135Accumulated deficit
    
    
    (60,864,842
    )
    
    
    (57,418,883
    )Total stockholders equity
    
    
    8,820,510
    
    
    
    5,277,800TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    19,998,910
    
    
    $
    13,493,183
 The accompanying notes to these consolidated financial statements are an integral part of these consolidated balance sheets. 2




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JMAR TECHNOLOGIES, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 For the Three Months Ended June 30, 2004 and 2003
 and Six Months Ended June 30, 2004 and 2003
 (Unaudited)
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenues
    
    $
    3,011,437
    
    
    $
    5,027,654
    
    
    $
    6,046,813
    
    
    $
    9,761,368Costs of revenues
    
    
    2,341,595
    
    
    
    4,055,835
    
    
    
    4,711,518
    
    
    
    7,878,565Gross profit
    
    
    669,842
    
    
    
    971,819
    
    
    
    1,335,295
    
    
    
    1,882,803Operating expenses:Selling, general and administrative
    
    
    1,160,075
    
    
    
    1,219,960
    
    
    
    2,285,849
    
    
    
    2,287,477Research and development
    
    
    14,677
    
    
    
    119,323
    
    
    
    68,774
    
    
    
    221,832Asset writedowns
    
    
    49,576
    
    
    
    200,056
    
    
    
    49,576
    
    
    
    306,149Costs associated with the BioSentry development
    
    
    213,520
    
    
    
    
    
    
    
    213,520
    
    
    
    Total operating expenses
    
    
    1,437,848
    
    
    
    1,539,339
    
    
    
    2,617,719
    
    
    
    2,815,458Loss from operations
    
    
    (768,006
    )
    
    
    (567,520
    )
    
    
    (1,282,424
    )
    
    
    (932,655
    )Interest and other income
    
    
    21,677
    
    
    
    42,866
    
    
    
    93,508
    
    
    
    66,457Interest and other expense
    
    
    (115,120
    )
    
    
    (125,700
    )
    
    
    (565,111
    )
    
    
    (230,826
    )Loss from continuing operations
    
    
    (861,449
    )
    
    
    (650,354
    )
    
    
    (1,754,027
    )
    
    
    (1,097,024
    )Income (loss) from operations of discontinued
operations
    
    
    74,546
    
    
    
    (686,830
    )
    
    
    12,449
    
    
    
    (1,146,817
    )Net loss
    
    
    (786,903
    )
    
    
    (1,337,184
    )
    
    
    (1,741,578
    )
    
    
    (2,243,841
    )Deemed preferred stock dividends
    
    
    (535,098
    )
    
    
    (224,030
    )
    
    
    (1,704,381
    )
    
    
    (229,453
    )Loss applicable to common stock
    
    $
    (1,322,001
    )
    
    $
    (1,561,214
    )
    
    $
    (3,445,959
    )
    
    $
    (2,473,294
    )Basic and diluted income (loss) per share:Loss per share from continuing
operations
    
    $
    (0.04
    )
    
    $
    (0.03
    )
    
    $
    (0.11
    )
    
    $
    (0.05
    )Income (loss) per share from discontinued
operations
    
    
    
    
    
    
    (0.03
    )
    
    
    
    
    
    
    (0.05
    )Basic and diluted loss per share applicable to
common stock
    
    $
    (0.04
    )
    
    $
    (0.06
    )
    
    $
    (0.11
    )
    
    $
    (0.10
    )Shares used in computation of basic and
diluted income (loss) per share:Basic
    
    
    30,885,182
    
    
    
    24,236,140
    
    
    
    30,286,846
    
    
    
    24,065,809Diluted
    
    
    33,368,351
    
    
    
    24,236,140
    
    
    
    32,770,014
    
    
    
    24,065,809
 The accompanying notes to these consolidated financial statements are an
integral part of these consolidated statements. 3




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JMAR TECHNOLOGIES, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 For the Six Months Ended June 30, 2004 and 2003
 (Unaudited)
 2004
    
    2003Cash flows from operating activities:Loss from continuing operations
    
    $
    (1,754,027
    )
    
    $
    (1,097,024
    )Adjustments to reconcile loss from continuing operations
to net cash used in continuing operations:Depreciation, amortization and debt discount
    
    
    676,858
    
    
    
    342,245Asset writedowns
    
    
    49,576
    
    
    
    306,149Services received in exchange for common stock or warrants
    
    
    4,499
    
    
    
    5,402Change in assets and liabilities:Accounts receivable, net
    
    
    (1,782,092
    )
    
    
    393,934Inventories
    
    
    43,141
    
    
    
    8,109Prepaid expenses and other
    
    
    106,029
    
    
    
    (293,628
    )Customer deposits
    
    
    
    
    
    
    (687,330
    )Accounts payable and accrued liabilities
    
    
    (97,856
    )
    
    
    (894,664
    )Net cash used in continuing operations operating activities
    
    
    (2,753,872
    )
    
    
    (1,916,807
    )Income (loss) from discontinued operations
    
    
    12,449
    
    
    
    (1,146,817
    )Changes in net assets and liabilities of discontinued operations
    
    
    (560,345
    )
    
    
    (390,530
    )Net cash used in discontinued operations
    
    
    (547,896
    )
    
    
    (1,537,347
    )Net cash used in operating activities
    
    
    (3,301,768
    )
    
    
    (3,454,154
    )Cash flows from investing activities:Capital expenditures
    
    
    (62,775
    )
    
    
    (48,542
    )Additions of intangible assets
    
    
    (112,601
    )
    
    
    (53,120
    )Net cash used in investing activities
    
    
    (175,376
    )
    
    
    (101,662
    )Cash flows from financing activities:Net proceeds from the issuance of preferred and common stock
    
    
    9,065,093
    
    
    
    1,957,974Payments of notes payable
    
    
    (1,051,905
    )
    
    
    Cash payments of preferred stock dividends
    
    
    (127,197
    )
    
    
    Net proceeds from the exercise of options
    
    
    157,275
    
    
    
    Net borrowings under line of credit
    
    
    
    
    
    
    614,819Decrease in restricted cash
    
    
    
    
    
    
    881,584Net cash provided by financing activities
    
    
    8,043,266
    
    
    
    3,454,377Net increase (decrease) in cash and cash equivalents
    
    
    4,566,122
    
    
    
    (101,439
    )Cash and cash equivalents, beginning of period
    
    
    4,171,179
    
    
    
    2,246,264Cash and cash equivalents, end of period
    
    $
    8,737,301
    
    
    $
    2,144,825Cash paid for interest
    
    $
    92,038
    
    
    $
    78,391
 During the six months ended June 30, 2004, the holder of Series C and D
Convertible Preferred Stock converted $3,500,000 of the preferred stock into
2,003,205 shares of common stock of the Company. The Company recorded
$1,769,759 related to the discount representing the beneficial conversion
feature of the redeemable convertible preferred stock and debt and the fair
value of warrants issued in connection with the preferred stock and debt (see
Notes 9 and 10). In addition, during the six months ended June 30, 2004,
$1,254,500 of the Companys working capital line of credit was converted into
1,048,913 shares of common stock of the Company (see Note 9). Also, during the
six months ended June 30, 2004, the Company repaid $364,239 in convertible
notes and $3,034 in accrued interest with the issuance of 118,121 shares of
common stock (see Note 9). The accompanying notes to these consolidated financial statements are an
integral part of these consolidated statements. 4




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JMAR TECHNOLOGIES, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (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. JMAR Technologies, Inc. develops, manufactures, and supports advanced
laser, sensor, and custom systems for applications in the semiconductor,
biotech, homeland security, nanotechnology and utility infrastructure markets.
The U.S. Department of Defense is the principal source of funds for the
Companys Collimated Plasma Lithography (CPL) light source, X-ray stepper
systems, and X-ray mask research and development programs. In addition to the
development of the above tools, JMAR provides semiconductor fabrication process
integration and maintenance support to the Department of Defenses Defense
Microelectronics Activity in Sacramento, California. In the first quarter of 2002, the Company decided to discontinue the
standard semiconductor products business. Also, during the later half of 2002,
the Company concluded that its precision equipment business did not fit with
the strategic direction of the Company 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 the precision
equipment 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 (see Note 8). The accompanying consolidated financial statements as of and for the three
and six months ended June 30, 2004 and 2003 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, 2003. The results of
operations for the three and six months ended June 30, 2004 are not necessarily
indicative of the results to be expected for the full year. (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 5




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) beginning after September 15, 2002. The Company has implemented SFAS
No. 143 effective January 1, 2003. The impact of such adoption did not have a
material effect on the Companys financial statements. Statement of Financial Accounting Standards No. 146 (SFAS 146),
Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146
addresses accounting and reporting costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity. This statement requires that a liability for a cost
associated with an exit or disposal activity shall be recognized and measured
initially at its fair value in the period which the liability is incurred. This
statement is effective for exit or disposal activities that are initiated after
December 31, 2002. The Company has implemented SFAS No. 146 effective January
1, 2003. The impact of such adoption did not have a material effect on its
financial statements. In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation  Transition and Disclosure  an amendment of SFAS No.
123. This statement provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. This statement also amends the disclosure requirements of SFAS
No. 123 and APB Opinion No. 28, Interim Financial Reporting, to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of
the method used on reported results. The Company has implemented SFAS No. 148
effective January 1, 2003 regarding disclosure requirements for condensed
financial statements for interim periods (see Note 3). The FASB has issued Interpretation No. 45, Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others,  an interpretation of FASB Nos. 5, 57 and 107 and
rescission of FASB Interpretation No. 34. This Interpretation elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued.
It also clarifies that a guarantor is required to recognize, at the inception
of a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and measurement provisions of
this Interpretation are applicable on a prospective basis to guarantees issued
or modified after December 31, 2002. Implementation of these provisions of the
Interpretation is not expected to have a material impact on the Companys
consolidated financial statements. The disclosure requirements of the
Interpretation are effective for financial statements of interim or annual
periods ended after December 15, 2002, and have been adopted in the
accompanying consolidated financial statements, with no additional disclosure
required. 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. The implementation of this
Interpretation did not 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 6




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) 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 was
required to be adopted for all new applicable revenue arrangements no later
than the third quarter of 2003. The implementation of EITF 00-21 did not have a
material effect on the Companys financial statements. 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 was 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 statements. In December 2003 the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 104 (SAB No. 104), Revenue Recognition to
update SAB No. 101, Revenue Recognition in Financial Statements. SAB No. 104
revises or rescinds portions of the interpretive guidance included in SAB No.
101 in order to make SAB No. 101 consistent with current authoritative
accounting and auditing guidance and SEC rules and regulations. The principal
revisions relate to the recission of material no longer necessary because of
private sector developments in U.S. generally accepted accounting principles.
SAB No. 104 also rescinds the Revenue Recognition in Financial Statements
Frequently Asked Questions and Answer document issued in conjunction with SAB
No. 101 and incorporates related portions of that document into SAB No. 104.
The adoption of SAB No. 104 did not have a material effect on the Companys
financial statements. (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 provided
for the issuance of warrants to JPSI employees (the JPSI Plans). The Company
is also 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 June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Loss applicable to common stock:
    
    As Reported
    
    $
    (1,322,001
    )
    
    $
    (1,561,214
    )
    
    $
    (3,445,959
    )
    
    $
    (2,473,294
    )Pro Forma
    
    
    (1,497,068
    )
    
    
    (1,785,797
    )
    
    
    (3,788,461
    )
    
    
    (2,918,340
    )Basic and diluted loss per share:
    
    As Reported
    
    
    (0.04
    )
    
    
    (0.06
    )
    
    
    (0.11
    )
    
    
    (0.10
    )Pro Forma
    
    
    (0.05
    )
    
    
    (0.07
    )
    
    
    (0.13
    )
    
    
    (0.12
    )
 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; expected dividend yields of 0 percent; and expected lives of 6 years.
For grants in 2004 and 2003, the expected volatility used was 259 percent and
275 percent, respectively. 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
450,000 shares under the JPSI Plan (Plans). In addition, 613,000 non-qualified
options have been granted to five
employees outside of the above plans. Except as noted below, under all
Plans, the option or warrant exercise price was 7




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) equal to or more than the
stocks market price on date of grant for grants made during the three and six
months ended June 30, 2004 and 2003 and no compensation expense was recognized.
Options for a total of 7,500 shares were granted to the Companys directors in
payment of meeting fees in the six months ended June 30, 2004, which had an
exercise price of $1.00 below the market price resulting in compensation
expense that was not significant. Options usually have a term of ten years and
vest one-third per year after date of grant. During the three and six months
ended June 30, 2004, 80,500 and 83,500 options, respectively, 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 June 30, 2004 and December 31, 2003, inventories
consisted of the following: June 30, 2004
    
    December 31, 2003(Unaudited)Raw materials, components and sub-assemblies
    
    $
    217,783
    
    
    $
    214,694Work-in-process
    
    
    45,074
    
    
    
    87,981Finished goods
    
    
    1,154
    
    
    
    4,477$
    264,011
    
    
    $
    307,152
 (5) Accounts Receivable At June 30, 2004 and December 31, 2003, accounts receivable consisted of
the following: June 30, 2004
    
    December 31, 2003(Unaudited)Trade
    
    $
    741,063
    
    
    $
    546,505Trade  unbilled
    
    
    105,871
    
    
    
    108,800U.S. Government  billed
    
    
    679,891
    
    
    
    522,123U.S. Government  unbilled
    
    
    3,057,292
    
    
    
    1,624,597$
    4,584,117
    
    
    $
    2,802,025
 All unbilled receivables at June 30, 2004 are expected to be billed and
collected within one year except for withheld contract fees of $168,027 which
will be billed and collected at the completion of the applicable contract.
Payment to the Company for performance on certain U.S. Government contracts is
subject to progress payment audits by the Defense Contract Audit Agency and are
recorded at the amounts expected to be realized. Included in the unbilled
amount is $2,329,522 related to the Companys contract with DARPA. The
Company expects DARPA to release $5.4 million in funding against its
DARPA contract in 2004. Of the remaining balance of unbilled receivables,
$348,167 is related to withheld fees for prior contracts to be billed pending
DCAA audit, and $317,447 is related to the normal billing cycle. (6) Property and Equipment At June 30, 2004 and December 31, 2003, property and equipment consisted
of the following: June 30, 2004
    
    December 31, 2003(Unaudited)Equipment and machinery
    
    $
    2,828,361
    
    
    $
    2,774,470Furniture and fixtures
    
    
    440,992
    
    
    
    435,043Leasehold improvements
    
    
    283,218
    
    
    
    280,2833,552,571
    
    
    
    3,489,796Less-accumulated depreciation
    
    
    (2,831,284
    )
    
    
    (2,698,023
    )$
    721,287
    
    
    $
    791,773
 8




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) (7) Segment Information The Company operates in three business segments, as follows: Research Division (formerly JMAR Research)  Located in San Diego,
California, this segment carries out contract research and development
involving JMARs patented high brightness (Britelight) lasers and
laser-produced plasma (LPP) technology. The results of this R&D are applied to
the Companys CPL light source, EUV generators, and related laser product
developments including X-ray microscopy and X-ray nano probe instruments. Until
recently, the exclusive focus of the Research Divisions R&D efforts has been
on advanced semiconductor lithography applications. In 2003, the Company
embarked on an effort to identify additional applications for its laser and LPP
technologies. Substantially all of the Research Divisions R&D is funded by
contracts from the Defense Advanced Research Projects Agency (DARPA) of the
U.S. Department of Defense. During the six months ended June 30, 2004 and 2003,
this segment accounted for approximately 40% and 31%, respectively, of the
Companys revenues. The technologies developed at the Research Division are transitioned to
JMARs Systems Division for product engineering and future production. Systems Division (formerly JMAR/SAL NanoLithography)  Located in Vermont,
this Division serves as JMARs product design and manufacturing arm, carrying
out the engineering, production, and integration of JMARs CPL light sources
and CPL stepper systems. The Systems Division also applies its engineering and
manufacturing expertise to the development of new products using a combination
of JMAR and third party technology, as in the case of its design and
manufacture of alpha and beta READ sensors for FemtoTrace, Inc. for
environmental and homeland security applications. During the six months ended
June 30, 2004 and 2003, this segment accounted for approximately 28% and 42%,
respectively, of the Companys revenues. Microelectronics Division (formerly JMAR Semiconductor)  This segment
provides process integration and maintenance support for the Defense
Microelectronics Activitys semiconductor fabrication facility in Sacramento,
California. It also designs and produces application specific integrated
circuits (ASICs) for military and commercial markets. During the six months
ended June 30, 2004 and 2003, this segment accounted for approximately 32% and
27%, 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 consolidated financial statements included
in the Form 10-K for the year ended December 31, 2003. 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 six months ended June 30, 2004 and
2003 (excluding discontinued operations) is as follows: Research
    
    Systems
    
    MicroelectronicsDivision
    
    Division
    
    Division
    
    Corporate
    
    TotalSix Months Ended June 30, 2004:Revenues
    
    $
    2,393,380
    
    
    $
    1,697,273
    
    
    $
    1,956,160
    
    
    $
    
    
    
    $
    6,046,813Operating loss
    
    
    (69,504
    )
    
    
    (822,164
    )
    
    
    (177,236
    )
    
    
    (213,520
    )
    
    
    (1,282,424
    )Asset writedown
    
    
    (49,576
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (49,576
    )Total assets
    
    
    4,373,871
    
    
    
    4,158,080
    
    
    
    1,522,999
    
    
    
    9,943,960
    
    
    
    19,998,910Goodwill
    
    
    
    
    
    
    3,790,907
    
    
    
    
    
    
    
    
    
    
    
    3,790,907Capital expenditures
    
    
    4,243
    
    
    
    18,978
    
    
    
    26,739
    
    
    
    12,815
    
    
    
    62,775Depreciation and
amortization
    
    
    82,300
    
    
    
    149,134
    
    
    
    14,342
    
    
    
    431,082
    
    
    
    676,858Three Months Ended June 30, 2004:Revenues
    
    
    1,289,573
    
    
    
    806,539
    
    
    
    915,325
    
    
    
    
    
    
    
    3,011,437
 9




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) Research
    
    Systems
    
    MicroelectronicsDivision
    
    Division
    
    Division
    
    Corporate
    
    TotalOperating income (loss)
    
    $
    71
    
    
    $
    (432,383
    )
    
    $
    (122,174
    )
    
    $
    (213,520
    )
    
    $
    (768,006
    )Asset writedown
    
    
    (49,576
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (49,576
    )Capital expenditures
    
    
    
    
    
    
    16,129
    
    
    
    24,106
    
    
    
    3,529
    
    
    
    43,764Depreciation and
amortization
    
    
    40,707
    
    
    
    75,100
    
    
    
    7,449
    
    
    
    86,294
    
    
    
    209,550Six Months Ended June 30, 2003:Revenues
    
    
    3,053,292
    
    
    
    4,099,364
    
    
    
    2,608,712
    
    
    
    
    
    
    
    9,761,368Operating income (loss)
    
    
    34,215
    
    
    
    (843,381
    )
    
    
    104,793
    
    
    
    (228,282
    )
    
    
    (932,655
    )Asset writedowns
    
    
    (306,149
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (306,149
    )Total assets
    
    
    2,588,993
    
    
    
    5,615,588
    
    
    
    1,692,140
    
    
    
    2,299,990
    
    
    
    12,196,711Goodwill
    
    
    
    
    
    
    3,790,907
    
    
    
    
    
    
    
    
    
    
    
    3,790,907Capital expenditures
    
    
    31,722
    
    
    
    2,578
    
    
    
    10,719
    
    
    
    3,523
    
    
    
    48,542Depreciation and
amortization
    
    
    117,494
    
    
    
    161,805
    
    
    
    10,885
    
    
    
    52,061
    
    
    
    342,245Three Months Ended June 30, 2003:Revenues
    
    
    1,603,742
    
    
    
    2,360,496
    
    
    
    1,063,416
    
    
    
    
    
    
    
    5,027,654Operating income (loss)
    
    
    (31,213
    )
    
    
    (473,168
    )
    
    
    60,778
    
    
    
    (123,917
    )
    
    
    (567,520
    )Asset writedown
    
    
    (200,056
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (200,056
    )Capital expenditures
    
    
    27,832
    
    
    
    2,578
    
    
    
    9,312
    
    
    
    3,523
    
    
    
    43,245Depreciation and
amortization
    
    
    59,687
    
    
    
    85,896
    
    
    
    6,189
    
    
    
    28,077
    
    
    
    179,849
 The asset writedown for 2004 of $49,576 relates to patent costs. The
asset writedowns for 2003 include $200,056 related to an asset held by the
Research Division that will not be used by the Company in the future and
$106,093 of patent costs written off. Sales to the United States Government totaled $1,856,315, $3,498,711,
$3,722,605 and $6,458,456 for the three and six months ended June 30, 2004 and
2003, respectively. In addition, sales to General Dynamics Advanced Information
Systems were $915,325, $1,950,106, $1,058,881 and $2,556,107 for the three and
six months ended June 30, 2004 and 2003, respectively. (8) Discontinued Operations The income from operations of discontinued operations of $74,546 and
$12,449 for the three and six months ended June 30, 2004, respectively, is
related to the former facility of the standard semiconductor products business.
The loss from operations of discontinued operations of $(686,830) and
$(1,146,817) for the three and six months ended June 30, 2003 includes $270,761
and $311,977, respectively, related to the standard semiconductor products
business and $416,069 and $834,840, 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 due to the sale of JPSI in July 2003. Prior to December 31, 2001, as the level of business expected from the
standard semiconductor products business did not materialize, the Company
decided to take action to sublease the Irvine facility and move the standard
semiconductor products business into a smaller facility and recorded a reserve
against the Irvine facility lease. The lease provides for rent and related
expenses of approximately $36,000 per month through August 2005. In June 2004,
the Company subleased the facility for the remaining term of the lease and
reduced the Companys reserve for this facility by approximately $112,000. 10




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) At June 30, 2004 and December 31, 2003, net liabilities of assets
discontinued consisted of the following: June 30,
    
    December 31,2004
    
    2003(Unaudited)Current Liabilities:Facility lease accrual
    
    $
    292,964
    
    
    $
    598,466Accounts payable
    
    
    35,231
    
    
    
    230,978Employee related contractual
commitments
    
    
    
    
    
    
    10,384Note payable
    
    
    72,443
    
    
    
    121,155$
    400,638
    
    
    $
    960,983
 (9) Line of Credit and Notes Payable In March 2003, the Company entered into a Revolving Fixed Price
Convertible Note (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. Laurus can convert any portion of the principal outstanding to common
stock at a fixed price per share (Conversion Price) any time the market price
of the Companys common stock is in excess of the Conversion Price. The Company
can convert a portion of the principal outstanding to common stock at 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. The
initial terms of the Working Capital Line provided that after $2 million of
conversions into equity, the Conversion Price would be increased. The
Conversion Price initially was $.92, but was increased to $2.85 in January 2004
after $2 million of the Working Capital Line had been converted at which time
the Company granted additional warrants for the purchase of 100,000 shares of
its common stock. During the six months ended June 30, 2004, $827,000 of the
Working Capital Line was converted into common stock at $.92 per share, or
898,913 shares, and $427,500 was converted into common stock at $2.85 per
share, or 150,000 shares (see Note 10). There was no balance outstanding under
the line at June 30, 2004. In connection with the Working Capital Line, the Company issued warrants
to Laurus to purchase 400,000 and 100,000 shares of common stock in March 2003
and January 2004, respectively, at prices ranging from $1.06 to $5.15 and paid
fees of $74,400 in March 2003. The Company recorded a discount of $412,633 and
$502,761 in March 2003 and January 2004, respectively, representing the
intrinsic value of the beneficial conversion feature and fair value of
warrants. At June 30, 2004, the unamortized discount and fees of $390,314 was
included in prepaid expenses and other in the accompanying Consolidated
Balance Sheet. In addition, there will be an additional beneficial conversion
feature in the amount of $210,923 recorded as additional borrowings are made
against the Working Capital Line. The discount is amortized over the remaining
life of the Working Capital Line or upon conversion, resulting in $66,098 and
$390,203 of interest expense for the three and six months ending June 30, 2004. In February 2004, the Company repaid $1.2 million in convertible notes,
plus accrued interest, issued to the former shareholders of SAL, by retiring a
total of $364,239 in notes and $3,034 in accrued interest with the issuance of
118,121 shares of common stock valued at $3.11 per share and repaying the
remaining amount of $835,761 in notes and accrued interest of $6,961 with cash. (10) Equity Transactions In January 2004, the Company sold for cash $1.5 million of 8 percent
Series E Convertible Preferred Stock (Series E Preferred) to Laurus at a fixed
conversion price of $2.85 per share. The Series E 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 eighteen equal monthly installments starting in August
2004, if not previously converted. Conversions to equity are
offset against the 11




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) required repayments. Except for the conversion price,
the conversion terms of the Series E Preferred are the same as the conversion
terms of the Working Capital Line (see Note 9). In February 2004, the Company sold for cash $8 million of 2 percent
Convertible Preferred Stock (Series F, G and H Preferred) to Laurus at a fixed
conversion price of $3.11 to $3.47 per share (depending upon the Series), with
an average conversion price of $3.34 per share. The Series F, G and H 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 eleven trading
days prior to the redemption date) in twenty-five equal monthly installments of
$150,000 starting in January 2005 with the balance redeemable in February 2007,
if not previously converted. Conversions to equity are offset against the
required repayments. Except for the conversion price, the conversion terms of
the Series F, G and H Preferred are the same as the conversion terms of the
Working Capital Line (see Note 9). As of August 9, 2004, the total outstanding preferred stock, warrants and
Working Capital Line held by Laurus are convertible or exercisable into
approximately 4.4 million shares. In connection with the above financing transactions with Laurus, the
Company issued to Laurus warrants to purchase 290,000 shares of common stock at

prices ranging from $3.42 to $5.00. In addition, in connection with the
adjustment to the conversion price on the Working Capital Line (see Note 9),
the Company issued to Laurus warrants to purchase 100,000 shares of common
stock at an exercise price of $5.15. As
a result of the convertible preferred stock and warrants issued in
2004, the
Company recorded a discount representing the beneficial conversion feature and
the fair value of the warrants issued of approximately $1.3 million. The
beneficial conversion feature was recognized during the first quarter of fiscal
year 2004 as a reduction of preferred stock and will be amortized to loss
applicable to common stock over the earlier of the redemption period or the
conversion dates. The following table summarizes the preferred stock activity through June
30, 2004. Six Months Ended June 30, 2004FinancingNet Balance at
    
    
    
    
    
    BCF andDecember 31,
    
    Gross
    
    Fair Value
    
    Fees and
    
    
    
    
    
    
    
    
    
    Net Balance atSeries
    
    2003
    
    Amount
    
    of Warrants
    
    Costs
    
    Amortization
    
    Conversions
    
    June 30, 2004C
    
    $
    875,223
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    624,777
    
    
    $
    1,500,000
    
    
    $
    D
    
    
    1,341,927
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    658,073
    
    
    
    2,000,000
    
    
    
    E
    
    
    
    
    
    
    1,500,000
    
    
    
    600,061
    
    
    
    62,000
    
    
    
    165,515
    
    
    
    
    
    
    
    1,003,454F
    
    
    
    
    
    
    2,000,000
    
    
    
    207,422
    
    
    
    72,062
    
    
    
    35,119
    
    
    
    
    
    
    
    1,755,635G
    
    
    
    
    
    
    2,000,000
    
    
    
    153,172
    
    
    
    72,062
    
    
    
    31,060
    
    
    
    
    
    
    
    1,805,826H
    
    
    
    
    
    
    4,000,000
    
    
    
    306,343
    
    
    
    144,125
    
    
    
    64,365
    
    
    
    
    
    
    
    3,613,897$
    2,217,150
    
    
    $
    9,500,000
    
    
    $
    1,266,998
    
    
    $
    350,249
    
    
    $
    1,578,909
    
    
    $
    3,500,000
    
    
    $
    8,178,812
 All of the preferred stock, warrants and the Working Capital Line (the
Securities) held by Laurus contain provisions that restrict the right of
Laurus to convert or exercise its JMAR securities in order to limit its
percentage beneficial ownership. If Laurus were to waive these beneficial
ownership limitations the Securities would be convertible for or exercisable
into more than 4.99% of the outstanding shares of the Companys common stock.
However, Laurus has not requested such a waiver. Laurus has also agreed that
none of the Securities shall be converted or exercised to the extent that
conversion or exercise of the Securities would result in Laurus beneficially
owning more than 19.9% of the Companys outstanding number of shares of common
stock unless and until the Company obtains stockholder approval in accordance
with NASDAQ corporate governance rules, or an exemption from the applicable
provision of NASDAQ corporate governance rules. 12




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) In
connection with all of the financing transactions with Laurus during
2003 and 2004, the
Company issued warrants to Laurus to purchase a total of 1,390,000 shares of
common stock at prices ranging from $1.058 to $5.15. In addition, Laurus was
granted the right to receive a warrant to purchase one share of common stock at
$3.13 for every $20 of principal of the Working Capital Line converted to
equity in excess of the first $2 million up to a total of 50,000 shares. During the six months ending June 30, 2004, the Company received proceeds
of $157,275 for the exercise of warrants and options into 71,933 shares of
common stock. During the six months ended June 30, 2004 and 2003, the Company
issued 2,322 and 8,304 shares of common stock for services. These issuances
were valued based upon the fair market value of the Companys common stock at
the date of issue. Included in the loss applicable to common stock in the Statement of
Operations for the three and six months ended June 30, 2004 and 2003 are
preferred stock dividends of $535,098, $1,704,381, $224,030 and $229,453,
respectively. The amount for the three and six months ended June 30, 2004
represents $65,471 and $125,472, respectively, of preferred stock dividends
paid or payable in cash and $469,627 and $1,578,909, respectively, related to
the discount representing the beneficial conversion feature of the redeemable
convertible preferred stock and the fair value of warrants issued in connection
with the preferred stock. The amount for the six months ended June 30, 2003
represents $27,604 of preferred stock dividends paid or payable in cash and
$201,849 related to the discount representing the beneficial conversion feature
of the redeemable convertible preferred stock and the fair value of warrants
issued in connection with the preferred stock. If not previously converted, the Series E through H Preferred Stock are
redeemable as follows: GrossAmountOutstanding
    
    Scheduled Redemptionsat June 30,Description
    
    2004
    
    2004
    
    2005
    
    2006
    
    2007
    
    TotalSeries E Preferred
    
    $
    1.5M
    
    
    $
    416,667
    
    
    $
    1,000,000
    
    
    $
    83,333
    
    
    $
    
    
    
    $
    1,500,000Series F Preferred
    
    $
    2.0M
    
    
    
    
    
    
    
    450,000
    
    
    
    450,000
    
    
    
    1,100,000
    
    
    
    2,000,000Series G Preferred
    
    $
    2.0M
    
    
    
    
    
    
    
    450,000
    
    
    
    450,000
    
    
    
    1,100,000
    
    
    
    2,000,000Series H Preferred
    
    $
    4.0M
    
    
    
    
    
    
    
    900,000
    
    
    
    900,000
    
    
    
    2,200,000
    
    
    
    4,000,000$
    416,667
    
    
    $
    2,800,000
    
    
    $
    1,883,333
    
    
    $
    4,400,000
    
    
    $
    9,500,000
 On
August 2, 2004, $85,000 of the Series E Preferred was
redeemed for cash. (11) Earnings 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 six
months ended June 30, 2003 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 June 30, 2004 and 2003, the Company
had shares issuable under outstanding warrants, stock options, convertible debt
and convertible preferred stock of 8,119,830 and 9,256,312, respectively. (12) Intangible Assets The Company adopted SFAS No. 142 Goodwill and Other Intangible Assets
(SFAS 142) effective January 1, 2002. In accordance with SFAS 142, the Company
does not amortize goodwill. The Companys goodwill of $3,790,907 at June 30,
2004 and December 31, 2003 is related to the Systems Division,
acquired 13




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) in August, 2001. As of June 30, 2004, the Company had the
following amounts related to other intangible assets: Gross Carrying
    
    Accumulated
    
    Net IntangibleAmount
    
    Amortization
    
    AssetsPatents
    
    $
    979,039
    
    
    $
    470,473
    
    
    $
    508,566Unpatented Technology
    
    
    450,000
    
    
    
    448,555
    
    
    
    1,445License
    
    
    86,250
    
    
    
    3,605
    
    
    
    82,645$
    592,656
 Aggregate amortization expense of the intangible assets with determinable
lives was $72,749 and $144,451 for the three and six months ended June 30,
2004, respectively. The unamortized balance of intangible assets is estimated
to be amortized as follows: For the Year Ended
    
    Estimated AmortizationDecember 31,
    
    Expense2004
    
    $
    21,6022005
    
    
    22,2482006
    
    
    22,2482007
    
    
    22,2482008
    
    
    22,2482009
    
    
    22,248Beyond
    
    
    459,814$
    592,656
 (13) BioSentry Development During the second quarter of 2004, the Company entered into an alliance
agreement with The LXT Group (LXT) to produce an early-warning system
(BioSentry) for the drinking water industry. As part of the agreement, JMAR
loaned the two principals of LXT $62,500 each and agreed to provide a maximum
financial commitment of $1 million, subject to the achievement of milestones by
LXT. Through June 30, 2004, the Company had provided approximately $224,000 of
financial support for costs incurred related to BioSentry, of which $213,520
was expensed. The majority of the remainder of the $1 million committed is
expected to be provided by the Company during 2004. Also, upon satisfaction of
certain conditions, the Company and LXT agreed to execute a purchase agreement
for the purchase by the Company of the LXT business. The purchase agreement is
intended to be signed in August 2004 with a closing expected in January 2005
after certain milestones are met and will provide for the purchase of all of
the assets of LXT for consideration consisting of $125,000 in cash,
cancellation of $125,000 in promissory notes held by the two principals of LXT
in favor of JMAR, 180,000 shares of JMAR common stock and certain contingent
earn-out payments based on future revenues and residual income generated by the
LXT business. (14) Subsequent Event Under the Merger Agreement entered into with the former shareholders and
creditors of SAL, Inc. (now operating as the Companys Systems Division), those
persons 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 could have
earned $500,000 in convertible notes upon the satisfaction of a lithography
demonstration milestone. This milestone was to be met 90 days after the
Companys CPL beta source satisfied certain negotiated source performance
criteria. In successful tests of the integrated system in March 2004, the
source demonstrated improved reliability and performance; 14




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) however, the specific source performance criteria specified in the Merger
Agreement have not yet been met. If issued, the $500,000 in Convertible Notes
would have been due 24 months after issuance and would have a conversion price
equal to 120% of the average of the closing prices for the ten days prior to
issuance. The third earnout condition could have resulted 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 was 180 days after the CPL source satisfied the above
mentioned source performance criteria. If earned, this earnout payment would
have been payable 30 days after delivery and acceptance of the system by the
customer. On July 9, 2004, the Company sent a letter to former shareholders and
creditors (Holders) of SAL, Inc. proposing a final resolution of the second and
third earnouts through payment of a total of $625,000 in shares of common
stock, valued at the average of the closing prices of JMARs common stock for
the five days during the period August 18, 2004 to August 24, 2004. Although
the Company has continued to improve the CPL source and it has recently
demonstrated improved lithographic performance, the CPL source does not yet
meet the specific technical criteria set forth in the Merger Agreement and,
therefore, the time to commence the required demonstration has not yet begun.
Specifically, although the CPL source has demonstrated throughput approaching
that required by the earnout, it has done so using a more sensitive resist than
that required by the earnout. Because of the open-ended nature of the earnout,
the payment of the second and third earnouts could be delayed for an
indeterminate time. Because of this uncertainty, the Company believed that the
current situation was unsatisfactory for both JMAR and the Holders. As of July
31, 2004, holders of more than 99 percent of the earnout interests
had accepted the Companys offer to receive the final payment of
$625,000 in common stock in full satisfaction of all remaining
amounts owed under the Merger Agreement. The value of the final payment will increase goodwill on the
accompanying Consolidated Balance Sheet for the quarter ended September 30,
2004. 15




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 
 Item 2. Overview JMAR Technologies, Inc. develops, manufactures, and supports advanced
laser, sensor, and custom systems for applications in the semiconductor,
biotech, homeland security, nanotechnology and utility infrastructure markets.
The U.S. Department of Defense is the principal source of funds for the
Companys collimated plasma lithography (CPL) light source, X-ray stepper
systems, and X-ray mask research and development programs. In addition to the
development of the above tools, JMAR provides semiconductor fabrication process
integration and maintenance support to the Department of Defenses Defense
Microelectronics Activity (DMEA) in Sacramento, California. Sources of Revenue Currently, over 90 percent of the Companys revenues are derived as the
prime contractor or subcontractor for government contracts. The most
significant ongoing contract has been the contract issued to JMARs Research
Division by the U.S. Army Research Laboratory sponsored by DARPA for further
development of the Companys CPL system (DARPA Contract). Through June 30,
2004, a total of $18.2 million has been received under this contract and the
Company expects to receive an additional $5.4 million in funding in 2004.
Although the funds are appropriated by Congress, DARPA controls the timing of
the funding. In late March and early April 2004, DARPA released $1.6 million
out of a total of $7 million in funding upon the successful completion of a
reliability and performance test which was completed on March 21, 2004. The
release of the remaining $5.4 million during 2004 is also subject to milestones
related to the further improvement of the beta source. The Company believes
that it will meet the milestones for release of all of the remaining $5.4
million. No program funding related to the DARPA Contract is included in the
United States Governments fiscal year 2005 budget and the Company expects no
further funding under this contract after the receipt of the remaining $5.4
million. JMARs next most significant contract is a $10 million contract issued to
JMARs Systems Division by Naval Air Warfare Center AD to procure sub-100 nm
X-ray masks used in the development and production of high performance GaAs
MMICs (NAVAIR Contract). Through June 30, 2004, a total of $6.4 million has
been received under this contract, and the Company expects to receive $2.1
million in funding in 2004. The funding for this contract has also been
appropriated by Congress. The third major ongoing revenue source involves the subcontract between
JMARs Microelectronics Division and General Dynamics Advanced Information
Systems (GDAIS) to enhance and maintain the semiconductor wafer fabrication
processes installed at the McClellan Air Force Base in Sacramento for the DMEA
(GDAIS Contract). This work, which started in 1998, has resulted in a new
subcontract each year out of funds available in the DMEAs budget as an element
of the Department of Defenses Advanced Technology Support Program. The Company
received $5 million and $3.5 million in contracts in 2003 and 2004,
respectively, for this program. The DARPA Contract has enabled the Company to carry out the science,
engineering, and characterization of a unique solid state laser based X-ray
source for advanced lithography. DARPAs mission has been fulfilled and it is
now up to the Company to turn the results of the R&D into new products and
growth for the Company. Our CPL X-ray generator provides the basis for
compact, short-wavelength light sources for a number of bio-science and
nanotechnology applications. For example, we are developing an innovative
X-ray microscope for use by the bio-science and chemical industries. In
addition, we are developing a soft X-ray Nano Probe for characterization of
nanostructures. Unrelated to JMARs work for DARPA, we are preparing to enter the
environmental and homeland security markets. The BioSentry sensor we are
developing with The LXT Group for continuous monitoring of drinking water for
microorganisms has successfully passed proof of concept testing. A
technologically advanced U.S. water utility is working with us to plan for
installation and testing of Beta units in early 2005.
On the chemical side, we are currently testing the Alpha Model READ sensor.
JMAR designed, 16




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##### Table of Contents



manufactured, and integrated this highly sensitive chemical
detection system for FemtoTrace and is looking forward to manufacturing a
number of beta and initial production units in 2005. Results of Operations Revenues. Total revenues for the three months ended June 30, 2004 and 2003
were $3,011,437 and $5,027,654, respectively. Total revenues for the six months
ended June 30, 2004 and 2003 were $6,046,813 and $9,761,368, respectively.
Revenues by segment for the three and six months ended June 30, 2004 and 2003
were as follows: Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Research Division
    
    $
    1,289,573
    
    
    $
    1,603,742
    
    
    $
    2,393,380
    
    
    $
    3,053,292Systems Division
    
    
    806,539
    
    
    
    2,360,496
    
    
    
    1,697,273
    
    
    
    4,099,364Microelectronics Division
    
    
    915,325
    
    
    
    1,063,416
    
    
    
    1,956,160
    
    
    
    2,608,712$
    3,011,437
    
    
    $
    5,027,654
    
    
    $
    6,046,813
    
    
    $
    9,761,368
 The decrease in revenues for the three and six months ended June 30, 2004
compared to the three and six months ended June 30, 2003 was primarily
attributable to a decrease in the NAVAIR Contract revenues of $1,132,342 and
$1,849,456, respectively, at the Systems Division due to the delay in replacing
IBM as the subcontractor on that contract, a decrease in revenues of the
Research and Systems Divisions related to the DARPA Contract of $573,618 and
$675,172, respectively, due to lower funding received on that contract, a
decrease of $232,676 and $787,358, respectively, related to two contracts at
the Systems Division that are nearing completion and a decrease in contract
revenues at the Microelectronics Division of $143,556 and $606,001,
respectively, related to less equipment installations under the GDAIS Contract
in 2004. The Company will continue to experience flat or lower revenues for
the remainder of 2004 and into 2005 until new product sales offsets the
decline in our DARPA funding for CPL. Losses. The net loss for the three months ended June 30, 2004 and 2003 was
$(786,903) and $(1,337,184), respectively. The loss from continuing operations
for those same periods was $(861,449) and $(650,354), respectively, while the
loss from operations for those same periods was $(768,006) and $(567,520),
respectively. The net loss for the six months ended June 30, 2004 and 2003 was
$(1,741,578) and $(2,243,841), respectively. The loss from continuing
operations for those same periods was $(1,754,027) and $(1,097,024),
respectively, while the loss from operations for those same periods was
$(1,282,424) and $(932,655), respectively. Included in the net loss for the three and six months ended June 30, 2004
is a gain from discontinued operations of $74,546 and $12,449, respectively.
Included in the net loss and loss from operations for the three and six months
ended June 30, 2004 are costs associated with the LXT BioSentry development
(see further discussion below) of $213,520 and an asset write down of $49,576.
Included in the net loss and loss from continuing operations for the three and
six months ended June 30, 2004 is a non-cash interest charge of $102,653 and
$470,508, respectively. Included in the net loss for the three and six months
ended June 30, 2003 is a loss from discontinued operations of $(686,830) and
$(1,146,817), respectively. Included in the net loss and loss from operations
for the three and six months ended June 30, 2003 are asset write downs of
$200,056 and $306,149, respectively. Included in the net loss and loss from
continuing operations for the three and six months ended June 30, 2003 is a
non-cash interest charge of $46,633 and $153,142, respectively. Gross Margins. Gross margins for the six months ended June 30, 2004 and
2003 were 22.1% and 19.3%, respectively. Gross margins for the three months
ended June 30, 2004 and 2003 were 22.2% and 19.3%, respectively. The Companys
margins are low because the majority of its revenues are from contract
revenues, which inherently generate lower margins than product revenues. The
primary increase in the gross margin for the three and six months ended June
30, 2004 compared to the three and six months
ended June 30, 2003 is due to lower revenues in 2004 on the lower margin NAVAIR
Contract (i.e., the lower margin NAVAIR Contract represented a greater percentage of revenues in 2003). The low margins on the NAVAIR Contract were due to the high
subcontract component of that contract and the 17




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##### Table of Contents



Companys absorption of some of
the costs incurred due to limited funding on that contract. In addition, the
gross margin on the GDAIS Contract was higher for the six months ended June 30,
2004 due to lower material costs in 2004 and a $70,000 contract cost overrun in
2003. These improvements were offset in part by a contract reserve of $100,000
and $271,000 for the three and six months ended June 30, 2004, respectively,
related to a contract at the Systems Division. The majority of the Companys
revenues for the remainder of 2004 and 2005 will be derived from contracts, so
gross margins are expected to continue at similar levels. Selling, General and Administrative (SG&A).SG&A expenses for the six
months ended June 30, 2004 and 2003 were $2,285,849 and $2,287,477,
respectively. SG&A expenses for the three months ended June 30, 2004 and 2003
were $1,160,075 and $1,219,960, respectively. The decrease in SG&A expenses for
the three months ended June 30, 2004 compared to the three months ended June
30, 2003 of $59,885 is primarily related to a decrease in SG&A costs of
approximately $225,000 at the Systems Division due to staff and other cost
reductions, offset in part by higher accounting and legal fees, insurance costs
and ISO 9000 costs. Research, Development and Engineering Program (RD&E).The Companys 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 $1,394,040 and $3,134,489 for the three months ended June 30, 2004 and
2003, respectively, and $2,724,722 and $5,541,764 for the six month periods
ended June 30, 2004 and 2003. The decrease in customer-funded RD&E expenditures
for the three and six months ended June 30, 2004 consists of a decrease of
$1,271,429 and $1,991,255, respectively, related to the Navair Contract,
decreases in two contracts winding down at the Systems Division of $39,222 and
$368,338, respectively, and a decrease of $429,798 and $469,609, respectively,
related to the DARPA Contract. Company-funded RD&E costs are shown in Operating Expenses and totaled
$14,677 and $119,323 for the three months ended June 30, 2004 and 2003,
respectively, and $68,774 and $221,832 for the six months ended June 30, 2004
and 2003, respectively. In addition, included in costs
associated with the BioSentry development
are $125,138 of research and development costs for the three and six
months ended June 30, 2004. Hence, total RD&E expenditures for the three month
periods were $1,533,855 and $3,253,812 for 2004 and 2003, respectively, and
$2,918,634 and $5,763,596 for the six month periods in 2004 and 2003. Total
RD&E expenditures as a percentage of revenues were 50.9% and 64.7% for the
three months ended June 30, 2004 and 2003, respectively, and 48.3% and 59.0%
for the six months ended June 30, 2004 and 2003, respectively. These
expenditures are primarily related to the continued development of collimated
plasma lithography systems for the semiconductor industry. The RD&E
expenditures as a percentage of revenues have been historically higher than
that for a commercially oriented company because much of the Companys revenues
has been R&D contract revenues. In February 2004, the Company received $8 million in financing from
Laurus. JMAR intends to use these funds to initiate and advance new product
research and development efforts and to acquire or license products,
technologies or businesses. Specifically, during the second quarter of 2004 the
Company has started product development on the BioSentry product line, and
during the third quarter of 2004, the Company has initiated the product
development of the X-ray Microscope and X-ray Nano Probe product lines.
Accordingly, the Company expects company-funded RD&E to increase significantly
for the remainder of 2004 and into 2005. Costs Associated with the BioSentry Development.During the second
quarter of 2004, the Company entered into an alliance agreement with The LXT
Group (LXT) to produce an early-warning system (BioSentry) for the drinking
water industry. As part of this agreement, JMAR agreed to provide a maximum
financial commitment of $1 million, subject to the achievement of specific
product development milestones by a joint LXT/JMAR team. For the second
quarter, the Company had expensed $213,520 of costs incurred related to
BioSentry product development. The majority of the remainder of the $1 million
commitment is expected to be invested by the Company during 2004. Discontinued Operations.The income from discontinued operations of
$74,546 and $12,449 for the three and six months ended June 30, 2004,
respectively, is related to the standard semiconductor products 18




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##### Table of Contents



business. The
loss from discontinued operations of $686,830 and $1,146,817 for the three and
six months ended June 30, 2003, respectively, includes $270,761 and $311,977,
respectively, related to the standard semiconductor products business and
$416,069 and $834,840, respectively, related to the precision equipment
business. The decrease in the loss from discontinued operations is due to the
sale of JPSI in July 2003. Prior to December 31, 2001, as the level of business expected from the
standard semiconductor products business did not materialize, the Company
decided to take action to sublease the Irvine facility and move the standard
semiconductor products business into a smaller facility and recorded a reserve
against the Irvine facility lease. The lease provides for rent and related
expenses of approximately $36,000 per month through August 2005. In June 2004,
the Company subleased the facility for the remaining term of the lease and
reduced the Companys reserve for this facility by approximately $112,000. Interest and Other Expense.Interest and other expense for the three
months ended June 30, 2004 and 2003 was $115,120 and $125,700, respectively,
and for the six months ended June 30, 2004 and 2003 was $565,111 and $230,826,
respectively. Interest and other expense is higher for the six months ended
June 30, 2004 versus the six months ended June 30, 2003 primarily due to the
financing transactions the Company entered into in late March 2003 and January
2004 (see Consolidated Liquidity and Financial Condition below). Included in
interest expense for the three and six months ended June 30, 2004 is $66,098
and $390,203, respectively, and $65,857 for the three and six months ended June
30, 2003 related to the beneficial conversion feature and fair value of
warrants issued in connection with the Working Capital Line, and was charged to
expense using the effective yield method based on the life of the debt, over
the period from the issuance date to the conversion dates. Also, interest
expense for the three and six months ended June 30, 2004 and 2003 includes
$36,555, $80,305, $46,633 and $87,285, respectively, related to the discounted
liability for the retirement in August 2002 of the Companys former Chairman
and Chief Executive Officer. Preferred Stock Dividends.Included in the loss applicable to common stock
in the Statement of Operations for the three and six months ended June 30, 2004
and 2003 are preferred stock dividends of $535,098, $1,704,381, $224,030 and
$229,453, respectively. The amount for the three and six months ended June 30,
2004 represents $65,471 and $125,472, respectively, of preferred stock
dividends paid or payable in cash and $469,627 and $1,578,909, respectively,
related to the discount representing the beneficial conversion feature of the
redeemable convertible preferred stock and the fair value of warrants issued in
connection with the preferred stock. The amount for the six months ended June
30, 2003 represents $27,604 of preferred stock dividends paid or payable in
cash and $201,849 related to the discount representing the beneficial
conversion feature of the redeemable convertible preferred stock and the fair
value of warrants issued in connection with the preferred stock. Consolidated Liquidity and Financial Condition Cash and cash equivalents at June 30, 2004 was $8,737,301. The increase in
cash and cash equivalents during the six months ended June 30, 2004 of
$4,566,122 resulted primarily from net proceeds from the issuance of preferred
and common stock of $9,065,093, offset in part by the repayment in cash of
$835,761 of the notes to the former SAL noteholders and cash used in continuing
operations of $2,753,872 (primarily related to operating losses and an increase
in accounts receivable), and cash used in discontinued operations of $547,896. JMAR will continue to use cash in 2004 and into 2005 for, among other
requirements, 1) product research and development efforts, including BioSentry development, and to acquire or
license products, technologies or businesses; 2) funding delays
related to government contracts; 3) corporate costs, primarily related to the
cost of being a public company; 4) preferred stock redemptions and dividends;
and 5) other working capital needs. As a result of
the financing activity discussed below, management believes that the Company
has adequate resources to fund working capital requirements
through June 30, 2005. However, 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. Working capital as of June
30, 2004 and December 31, 2003 was $12,076,239 and $2,427,166,
respectively. The increase in working capital is primarily due to gross
proceeds from the issuance of preferred stock of $9.5 million and the 19




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##### Table of Contents



conversion into common stock of $1,254,500 of the Companys line of credit,
offset in part by the Companys losses. In March 2003, the Company entered into a Revolving Fixed Price
Convertible Note (Working Capital Line) with 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. Laurus can
convert any portion of the principal outstanding to common stock at a fixed
price per share (Conversion Price) any time the market price of the Companys
common stock is in excess of the Conversion Price. The Company can convert a
portion of the principal outstanding to common stock at 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. The initial terms of the
Working Capital Line provided that after $2 million of conversions into equity,
the Conversion Price would be increased. The Conversion Price initially was
$.92, but was increased to $2.85 in January 2004 after $2 million of the
Working Capital Line had been converted. The interest rate on the Working Capital Line is equal to the prime rate
(4% at June 30, 2004) plus 0.75 percent, subject to a floor of 5.00 percent.
Accrued interest is payable monthly. The Working Capital Line requires that the
Companys quick ratio, as defined, be 0.90 or higher. The quick ratio is
defined as the sum of cash and accounts receivable divided by the sum of
current liabilities, exclusive of current liabilities of discontinued
operations. The Companys quick ratio was 6.29 at June 30, 2004. As of June 30,
2004, there was no amount 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 $2.1 million at June 30,
2004, all of which was unused at June 30, 2004. In 2003 and 2004, the Company sold the following series of Preferred Stock
to Laurus for cash: Converted in 2003
    
    Converted in 2004Shares
    
    
    
    
    
    SharesIssuance Date
    
    Series
    
    Amount
    
    Dividend
    
    Conversion Price
    
    Amount
    
    Issued
    
    Amount
    
    IssuedMarch, 2003
    
    
    A
    
    
    $
    1,000,000
    
    
    
    8
    %
    
    $
    0.88
    
    
    $
    1,000,000
    
    
    
    1,136,363
    
    
    
    
    
    
    
    March, 2003
    
    
    B
    
    
    $
    1,000,000
    
    
    
    3
    %
    
    $
    0.88
    
    
    $
    1,000,000
    
    
    
    1,136,364
    
    
    
    
    
    
    
    September, 2003
    
    
    C
    
    
    $
    1,500,000
    
    
    
    8
    %
    
    $
    2.08
    
    
    
    
    
    
    
    
    
    
    $
    1,500,000
    
    
    
    721,154December, 2003
    
    
    D
    
    
    $
    2,000,000
    
    
    
    8
    %
    
    $
    1.56
    
    
    
    
    
    
    
    
    
    
    $
    2,000,000
    
    
    
    1,282,051January, 2004
    
    
    E
    
    
    $
    1,500,000
    
    
    
    8
    %
    
    $
    2.85
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February, 2004
    
    
    F
    
    
    $
    2,000,000
    
    
    
    2
    %
    
    $
    3.11
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February, 2004
    
    
    G
    
    
    $
    2,000,000
    
    
    
    2
    %
    
    $
    3.28
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February, 2004
    
    
    H
    
    
    $
    4,000,000
    
    
    
    2
    %
    
    $
    3.47
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 The Series E, F, G and H Preferred Stock are redeemable in cash (or common
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) at various amounts and dates (see below under Commitments), if not
previously converted. Conversions to equity are offset against the required
repayments. Except for the conversion price, the conversion terms of the Series
E through H Preferred Stock are the same as the conversion terms of the Working
Capital Line. In connection with all of the above financing transactions with Laurus,
the Company issued warrants to Laurus to purchase a total of 1,390,000 shares
of common stock at prices ranging from $1.058 to $5.15. In addition, Laurus was
granted the right to receive a warrant to purchase one share of common stock at
$3.13 for every $20 of principal of the Working Capital Line converted to
equity in excess of the first $2 million up to a total of 50,000 shares. The shares of common stock issuable to Laurus under all of the preferred
stock and warrants described above have been included in registration
statements declared effective by the Securities and Exchange Commission. 20




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##### Table of Contents



The Companys stockholders equity was $8,820,510 as of June 30, 2004. In
May, 2003, the Company transferred to the Nasdaq SmallCap Market, where it is
required to maintain no less than $2.5 million of stockholders equity to
retain its listing. Substantial 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. In February 2004 the Company received approximately $3.5 million in
additional contracts from General Dynamics and in late March 2004 and early
April 2004, DARPA released $1.6 million in funding. In addition, JMAR expects
to receive approximately $5.4 million in additional CPL contract funding from
DARPA and another $2.1 million in funds from NAVAIR. Commitments Future minimum annual commitments under non-cancellable operating leases
(net of subleases), BioSentry development costs and post-employment benefits as
of June 30, 2004 are as follows (unaudited): 2004
    
    2005
    
    2006
    
    2007
    
    Thereafter
    
    TotalOperating leases
    
    $
    447,312
    
    
    $
    460,453
    
    
    $
    42,761
    
    
    $
    2,791
    
    
    $
    4,187
    
    
    $
    957,504BioSentry
development
    
    
    776,385
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    776,385Post-employment
benefits
    
    
    105,586
    
    
    
    282,377
    
    
    
    269,377
    
    
    
    269,377
    
    
    
    254,484
    
    
    
    1,181,201$
    1,329,283
    
    
    $
    742,830
    
    
    $
    312,138
    
    
    $
    272,168
    
    
    $
    258,671
    
    
    $
    2,915,090
 The operating leases are primarily for office facilities. The
post-employment benefits are presented at the total amount to be paid, whereas
the liability has been discounted for financial reporting purposes. Excluded from the above table are redemption obligations under Series E,
F, G and H Preferred Stock in the gross amount of $9.5 million. Also excluded
from the above table is the Companys $3 million Working Capital Line, of which
none was outstanding at June 30, 2004. If not previously converted, the Series
E through H Preferred Stock are redeemable as follows: GrossAmountOutstanding
    
    Scheduled Redemptionsat June 30,Description
    
    2004
    
    2004
    
    2005
    
    2006
    
    2007
    
    TotalSeries E Preferred
    
    $
    1.5M
    
    
    $
    416,667
    
    
    $
    1,000,000
    
    
    $
    83,333
    
    
    $
    
    
    
    $
    1,500,000Series F Preferred
    
    $
    2.0M
    
    
    
    
    
    
    
    450,000
    
    
    
    450,000
    
    
    
    1,100,000
    
    
    
    2,000,000Series G Preferred
    
    $
    2.0M
    
    
    
    
    
    
    
    450,000
    
    
    
    450,000
    
    
    
    1,100,000
    
    
    
    2,000,000Series H Preferred
    
    $
    4.0M
    
    
    
    
    
    
    
    900,000
    
    
    
    900,000
    
    
    
    2,200,000
    
    
    
    4,000,000$
    416,667
    
    
    $
    2,800,000
    
    
    $
    1,883,333
    
    
    $
    4,400,000
    
    
    $
    9,500,000
 Under the Merger Agreement entered into with the former shareholders and
creditors of SAL, Inc. (now operating as the Companys Systems Division), those
persons 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 could have
earned $500,000 in convertible notes upon the satisfaction of a lithography
demonstration milestone. This milestone was to be met 90 days after the
Companys CPL beta source satisfied certain negotiated source performance
criteria. In successful tests of the integrated system in March 2004, the
source demonstrated improved reliability and performance;
however, the specific source performance criteria specified in the Merger
Agreement have not yet been met. 21




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If issued, the $500,000 in Convertible Notes
would have been due 24 months after issuance and would have a conversion price
equal to 120% of the average of the closing prices for the ten days prior to
issuance. The third earnout condition could have resulted 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 was 180 days after the CPL source satisfied the above
mentioned source performance criteria. If earned, this earnout payment would
have been payable 30 days after delivery and acceptance of the system by the
customer. On July 9, 2004, the Company sent a letter to former shareholders and
creditors (Holders) of SAL, Inc. proposing a final resolution of the second and
third earnouts through payment of a total of $625,000 in shares of common
stock, valued at the average of the closing prices of JMARs common stock for
the five days during the period August 18, 2004 to August 24, 2004. Although
the Company has continued to improve the CPL source and it has recently
demonstrated improved lithographic performance, the CPL source does not yet
meet the specific technical criteria set forth in the Merger Agreement and,
therefore, the time to commence the required demonstration has not yet begun.
Specifically, although the CPL source has demonstrated throughput approaching
that required by the earnout, it has done so using a more sensitive resist than
that required by the earnout. Because of the open-ended nature of the earnout,
the payment of the second and third earnouts could be delayed for an
indeterminate time. Because of this uncertainty, the Company believed that the
current situation was unsatisfactory for both JMAR and the Holders. As of July
31, 2004, holders of more than 99 percent of the earnout interests
had accepted the Companys offer to receive the final payment of
$625,000 in common stock in full satisfaction of all remaining
amounts owed under the Merger Agreement. During the second quarter of 2004, the Company entered into an alliance
agreement with The LXT Group (LXT) to produce an early-warning system
(BioSentry) for the drinking water industry. As part of the agreement, JMAR
loaned the two principals of LXT $62,500 each and agreed to provide a maximum
financial commitment of $1 million, subject to the achievement of milestones by
LXT. Through June 30, 2004, the Company had provided approximately $224,000 of
financial support for costs incurred related to BioSentry. The majority of the
remainder of the $1 million committed is expected to be provided by the Company
during 2004. Also, upon satisfaction of certain conditions, the Company and LXT
agreed to execute a purchase agreement for the purchase by the Company of the
LXT business. The purchase agreement is intended to be signed in August 2004
with a closing expected in January 2005 after certain milestones are met and
will provide for the purchase of all of the assets of LXT for consideration
consisting of $125,000 in cash, cancellation of $125,000 in promissory notes
held by the two principals of LXT in favor of JMAR, 180,000 shares of JMAR
common stock and certain contingent earn-out payments based on future revenues
and residual income generated by the LXT business. At December 31, 2003, the Company had approximately $57 million of Federal
net operating loss carryforwards subject to certain annual limitations, which
expire from 2004 through 2023. 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. 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, goodwill and intangible assets, beneficial
conversion feature, deferred taxes, litigation accrual 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 22




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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 are fully charged to operations when
identified. Actual costs could differ from these estimated costs. 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 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. Patent costs capitalized
are amortized over ten years, and other intangible assets are amortized over
not more than five years. Patent costs capitalized are reviewed quarterly for
realizability. Beneficial Conversion Feature In accordance with Financial Accounting Standards Board (FASB) Emerging
Issues Task Force Issue (EITF) No. 98-5 and FASB EITF No. 00-27, the Company
records a beneficial conversion feature (BCF) related to the issuance of
convertible preferred stock and convertible debt that have conversion features
at fixed rates that are in-the-money when issued and records the fair value of
warrants issued with those instruments. The BCF for the convertible instruments
and fair value of warrants is recognized and measured by allocating a portion
of the proceeds to additional paid-in capital and as a discount to the
convertible instrument equal to the intrinsic value of the conversion features.
Such amount is calculated at the issuance date as the difference between the
conversion price and the relative fair value of the common stock and warrants
into which the security is convertible or exercisable. For convertible preferred stock and related warrants, the recorded
discount is recognized as a dividend from the date of issuance to the earlier
of the redemption dates or the conversion dates using the effective yield
method. For convertible debt and related warrants, the recorded discount is
recognized as interest expense using the effective yield method based on the
life of the debt, over the period from the issuance date to the conversion
dates. 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. 23




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##### Table of Contents



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. 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 calculated based
on the Black-Scholes pricing model. 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 new products into the commercial marketplace or to apply those
products, projects or processes to alternative applications are forward-looking
statements. These forward-looking statements 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. In addition to the several risks and uncertainties described in this
Managements Discussion and Analysis of Financial Condition and Results of
Operations, additional risks and uncertainties include the following:  
    
    delays and unanticipated technological or engineering difficulties in
the Companys new product development efforts, which involve lengthy and
capital intensive programs that are subject to many unforeseen risks,
delays, problems and costs and uncertainties as to the markets demand
for such new products;
    
    the risk that the technologies related to our new product
development activities may infringe on issued patents held by
others;
    
    the lack of funds to support our CPL business area due to delays in funding or cancellation of government
contracts;
    
    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, for working capital needs or for development of
the Companys new products;
    
    the inability to achieve the levels of power and reliability
in its CPL source required to enter the GaAs market, despite the
expenditure of additional significant funds;
    
    the continued delay in the recovery of the GaAs chip market resulting
in further delays in the demand for the increased throughput offered by
the Companys CPL system;
    
    despite substantial technical, marketing and sales efforts and the
expenditure of significant funds by the Company, the failure to convince
semiconductor manufacturers to adopt the Companys CPL technology over
other existing and possible future alternative lithography technologies,
including the use of electron beam systems for GaAs chip manufacturing,
193 immersion lithography for silicon contact hole processing and EUV
lithography for future mainstream silicon manufacturing; 24




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##### Table of Contents




    
    the lack of availability of critical components from third party
suppliers, including laser diodes, x-ray optics, x-ray masks and
photo-resist, or the inability to obtain such components at acceptable
costs;
    
    fluctuations in margins, or the failure to lower manufacturing costs
sufficiently to achieve acceptable margins;
    
    the failure of pending patents to be issued and uncertainties as to
the breadth or degree of protection of existing or future patents
covering the Companys x-ray and other technologies and
applications; and
    
    other risks detailed in the Companys Form 10-K for the year ended
December 31, 2003 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 June 30, 2004 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 quarter ended June 30, 2004 that have
materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting. The
Company is not an accelerated filer and, therefore, the
internal controls certification and attestation requirements of
Section 404 of the Sarbanes-Oxley Act are not applicable to the
Company until 2005. However, during the second quarter of 2004, the Company has been reviewing and
testing its internal control procedures and it retained an outside
firm to assist in this process. 25




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##### Table of Contents



PART II  OTHER INFORMATION 
 Item 2.Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. (c)(i)
Pursuant to the Non-Employee Directors Equity Plan approved by the
Companys Shareholders on June 25, 2004, on that date the Company issued a total of 2,322 shares of Common Stock to its outside directors as
compensation for services as directors. These transactions were exempt
under Section 4(2) of the Securities Act of 1933. 
 Item 4.Submission of Matters to a Vote of Security Holders. At the Companys Annual Meeting of Shareholders held on June 25, 2004, the
following matters were voted on: (a) The following directors were elected: C. Neil Beer (27,063,850
affirmative votes and 2,105,058 votes withheld); Vernon H. Blackman
(27,075,900 affirmative votes and 2,093,008 votes withheld); Charles A.
Dickinson (27,080,025 affirmative votes and 2,088,883 votes withheld);
John S. Martinez (26,960,335 affirmative votes and 2,208,573 votes
withheld); Edward P. OSullivan II (28,299,759 affirmative votes and
869,149 votes withheld); Barry Ressler (27,090,834 affirmative votes and
2,078,074 votes withheld); Ronald A. Walrod (27,196,004 affirmative votes
and 1,972,904 votes withheld). (b) The
proposal to ratify the selection of Grant Thornton, LLP as the
Companys independent auditor for the fiscal year ending December 31, 2004
was approved with 28,883,851 affirmative votes, 134,831 negative votes and
150,226 abstaining votes. There were no broker non-votes for this
item. (c) The proposal to approve an amendment to the Companys Certificate of
Incorporation to increase the authorized Common Stock from 40,000,000 to
80,000,000 shares was approved with 26,804,159 affirmative votes, 2,218,503
negative votes and 146,246 abstaining votes. There were no broker
non-votes for this item. (d) The
proposal to approve the Non-Employee Directors Equity Plan to
authorize a total of 100,000 shares of Common Stock for the payment of
Board and Committee meeting fees was passed with 6,327,663 affirmative
votes, 1,984,505 negative votes, 233,207 abstaining votes and
20,623,533 broker non-votes. 
 Item 6.Exhibits and Reports on Form 8-K. (a) Exhibits Exhibit 10.1
    
    Alliance Agreement, dated June 10, 2004, between the
Company and Gregory Quist and David Drake, d/b/a The LXT Group.Exhibit 10.2
    
    Promissory Notes, dated June 10, 2004, executed by
Quist and Drake in favor of the Company.Exhibit 31.1
    
    Certification of CEO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.Exhibit 31.2
    
    Certification of CFO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.Exhibit 32.1
    
    Certification pursuant to 18 U.S.C. Section 1350, as
adopted 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 April 1, 2004 related to
the announcement of its financial results for the year ended
December 31, 2003. 26




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##### 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.August 13, 2004
    
    By:
    
    
    /s/ Ronald A. WalrodRonald A. Walrod, Chief Executive Officer
and Authorized OfficerBy:
    
    
    /s/ Dennis E. ValentineDennis E. Valentine, Chief Accounting Officer
 27