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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 September 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 (November 8, 2004). Common Stock, $.01 par value: 31,370,777 shares




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INDEX Page #PART I. FINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated Balance Sheets  September 30,
2004 (unaudited) and December 31, 2003
    
    
    2Consolidated Statements of Operations (unaudited)
 Three months and nine months ended September 30, 2004 and 2003
    
    
    3Consolidated Statements of Cash Flows (unaudited)
 Nine months ended September 30, 2004 and 2003
    
    
    4Notes to Consolidated Financial Statements
(unaudited)
    
    
    5Item 2. Managements Discussion and
Analysis of Financial Condition and Results of Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosures
About Market Risk
    
    
    24Item 4. Controls and Procedures
    
    
    24PART II. OTHER INFORMATIONItem 1. N/AItem 2. Unregistered Sales of Equity Securities
and Use of Proceeds
    
    
    25Item 3. N/AItem 4. N/AItem 5.
Other Information
    
    
    25Item 6. Exhibits
    
    
    25EXHIBIT 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 September 30, 2004 and December 31, 2003
 September 30, 2004
    
    December 31, 2003(Unaudited)ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    7,061,926
    
    
    $
    4,171,179Accounts receivable, net
    
    
    4,239,730
    
    
    
    2,802,025Inventories
    
    
    195,721
    
    
    
    307,152Prepaid expenses and other
    
    
    714,606
    
    
    
    695,170Total current assets
    
    
    12,211,983
    
    
    
    7,975,526Property and equipment, net
    
    
    889,652
    
    
    
    791,773Intangible assets, net
    
    
    586,796
    
    
    
    684,041Other assets
    
    
    635,056
    
    
    
    250,936Goodwill, net
    
    
    4,415,932
    
    
    
    3,790,907TOTAL ASSETS
    
    $
    18,739,419
    
    
    $
    13,493,183LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    784,607
    
    
    $
    1,102,873Accrued liabilities
    
    
    516,779
    
    
    
    561,716Accrued payroll and related costs
    
    
    876,863
    
    
    
    582,357Line of credit and notes payable, net of discount
    
    
    
    
    
    
    2,340,431Current liabilities of discontinued operations, including notes
payable
    
    
    325,548
    
    
    
    960,983Total current liabilities
    
    
    2,503,797
    
    
    
    5,548,360Notes payable and other long-term liabilities, net of current
portion
    
    
    466,474
    
    
    
    449,873Redeemable convertible preferred stock, 950,000 shares issued and
outstanding as of September 30, 2004 and 350,000 shares as of
December 31, 2003
    
    
    8,174,710
    
    
    
    2,217,150Stockholders equity:Preferred stock, $.01 par value; 5,000,000 shares authorized;
950,000
shares issued and outstanding as of September 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 31,370,777 shares as of September 30, 2004 and 27,654,845
shares as of December 31, 2003
    
    
    313,708
    
    
    
    276,548Additional-paid in capital
    
    
    70,075,388
    
    
    
    62,420,135Accumulated deficit
    
    
    (62,794,658
    )
    
    
    (57,418,883
    )Total stockholders equity
    
    
    7,594,438
    
    
    
    5,277,800TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    18,739,419
    
    
    $
    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 September 30, 2004 and 2003
 and Nine Months Ended September 30, 2004 and 2003
 (Unaudited)
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenues
    
    $
    2,257,737
    
    
    $
    3,964,930
    
    
    $
    8,304,550
    
    
    $
    13,726,298Costs of revenues
    
    
    2,042,918
    
    
    
    2,981,708
    
    
    
    6,754,436
    
    
    
    10,860,273Gross profit
    
    
    214,819
    
    
    
    983,222
    
    
    
    1,550,114
    
    
    
    2,866,025Operating expenses:Selling, general and administrative
    
    
    1,070,065
    
    
    
    1,116,762
    
    
    
    3,355,914
    
    
    
    3,393,840Research and development
    
    
    286,889
    
    
    
    176,100
    
    
    
    355,663
    
    
    
    397,932Costs associated with the BioSentry development
    
    
    373,106
    
    
    
    
    
    
    
    586,626
    
    
    
    Asset write-downs
    
    
    35,737
    
    
    
    
    
    
    
    85,313
    
    
    
    306,149Total operating expenses
    
    
    1,765,797
    
    
    
    1,292,862
    
    
    
    4,383,516
    
    
    
    4,097,921Loss from operations
    
    
    (1,550,978
    )
    
    
    (309,640
    )
    
    
    (2,833,402
    )
    
    
    (1,231,896
    )Interest and other income
    
    
    17,922
    
    
    
    3,801
    
    
    
    111,430
    
    
    
    59,859Interest and other expense
    
    
    (110,253
    )
    
    
    (264,649
    )
    
    
    (675,364
    )
    
    
    (495,475
    )Loss from continuing operations
    
    
    (1,643,309
    )
    
    
    (570,488
    )
    
    
    (3,397,336
    )
    
    
    (1,667,512
    )Discontinued operations:Loss from operations of discontinued operations
    
    
    (52,549
    )
    
    
    (258,673
    )
    
    
    (40,100
    )
    
    
    (1,405,490
    )Gain on disposal of discontinued operations
    
    
    
    
    
    
    205,000
    
    
    
    
    
    
    
    205,000Net loss
    
    
    (1,695,858
    )
    
    
    (624,161
    )
    
    
    (3,437,436
    )
    
    
    (2,868,002
    )Deemed preferred stock dividends
    
    
    (233,958
    )
    
    
    (439,290
    )
    
    
    (1,938,339
    )
    
    
    (668,743
    )Loss applicable to common stock
    
    $
    (1,929,816
    )
    
    $
    (1,063,451
    )
    
    $
    (5,375,775
    )
    
    $
    (3,536,745
    )Basic and diluted loss per share:Loss per share from continuing operations
    
    $
    (0.06
    )
    
    $
    (0.04
    )
    
    $
    (0.17
    )
    
    $
    (0.09
    )Loss per share from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.05
    )Basic and diluted loss per share applicable to
common stock
    
    $
    (0.06
    )
    
    $
    (0.04
    )
    
    $
    (0.17
    )
    
    $
    (0.14
    )Shares used in computation of basic and
diluted loss per share:Basic
    
    
    31,088,814
    
    
    
    25,500,260
    
    
    
    32,010,917
    
    
    
    24,550,380Diluted
    
    
    31,088,814
    
    
    
    25,500,260
    
    
    
    32,010,917
    
    
    
    24,550,380
 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 Nine Months Ended September 30, 2004 and 2003
 (Unaudited)
 2004
    
    2003Cash flows from operating activities:Loss from continuing operations
    
    $
    (3,397,336
    )
    
    $
    (1,667,512
    )Adjustments to reconcile loss from continuing operations
to net cash used in continuing operations:Depreciation, amortization and debt discount
    
    
    848,934
    
    
    
    683,554Asset write-downs
    
    
    85,313
    
    
    
    306,149Services received in exchange for common stock or
warrants
    
    
    8,999
    
    
    
    7,200Change in assets and liabilities:Accounts receivable, net
    
    
    (1,437,705
    )
    
    
    170,437Inventories
    
    
    111,431
    
    
    
    43,343Prepaid expenses and other
    
    
    (19,784
    )
    
    
    (238,053
    )Customer deposits
    
    
    
    
    
    
    (755,803
    )Accounts payable and accrued liabilities
    
    
    (52,096
    )
    
    
    (1,057,999
    )Net cash used in continuing operations operating
activities
    
    
    (3,852,244
    )
    
    
    (2,508,684
    )Loss from discontinued operations
    
    
    (40,100
    )
    
    
    (1,200,490
    )Changes in net assets and liabilities of discontinued
operations
    
    
    (635,435
    )
    
    
    (243,077
    )Net cash used in discontinued operations
    
    
    (675,535
    )
    
    
    (1,443,567
    )Net cash used in operating activities
    
    
    (4,527,779
    )
    
    
    (3,952,251
    )Cash flows from investing activities:Capital expenditures
    
    
    (315,256
    )
    
    
    (57,064
    )Additions of intangible assets
    
    
    (159,228
    )
    
    
    (193,621
    )Net cash used in investing activities
    
    
    (474,484
    )
    
    
    (250,685
    )Cash flows from financing activities:Net proceeds from the issuance of preferred and common
stock
    
    
    9,057,914
    
    
    
    4,279,413Payments of notes payable
    
    
    (958,647
    )
    
    
    Cash payments of preferred stock dividends
    
    
    (196,865
    )
    
    
    (40,113
    )Preferred stock redemptions
    
    
    (166,667
    )
    
    
    Net proceeds from the exercise of options
    
    
    157,275
    
    
    
    Net payments under line of credit
    
    
    
    
    
    
    (1,449,146
    )Decrease in restricted cash
    
    
    
    
    
    
    1,360,296Net cash provided by financing activities
    
    
    7,893,010
    
    
    
    4,150,450Net increase (decrease) in cash and cash equivalents
    
    
    2,890,747
    
    
    
    (52,486
    )Cash and cash equivalents, beginning of period
    
    
    4,171,179
    
    
    
    2,246,264Cash and cash equivalents, end of period
    
    $
    7,061,926
    
    
    $
    2,193,778Cash paid for interest
    
    $
    132,571
    
    
    $
    237,629
 During the nine months ended
September 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
a discount of $1,769,759 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
transactions in 2004 (see Notes 9 and 10). In addition, during the nine months
ended September 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 nine months ended September 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). During the nine months
ended September 30, 2004, the Company issued 475,666 shares of common stock to
the former shareholders and creditors of SAL, Inc. in full satisfaction of
outstanding earn-outs relating to the acquisition of SAL, Inc. (see Note 10). 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. is a leading innovator in the
development of
laser-based equipment for imaging, analysis and fabrication at the nano-scale.
The Company is leveraging over a decade of laser and photonics research to
develop a diverse portfolio of products with commercial applications in rapidly
growing industries while continuing to provide support for the U.S.
Governments Defense Microelectronics Activity (DMEA) semiconductor fabrication
facility. JMAR is targeting the nanotech, bioscience and semiconductor
industries with its Britelight laser; Compact X-ray Light Source; X-ray
Microscope  for 3D visualization of single cells and polymers; and its X-ray
Nano Probe  enabling interaction, analysis and modification at the nano-scale.
JMAR also maintains strategic alliances for the development of
BioSentry and
READ  biological and chemical sensors for homeland security, environmental and
utility infrastructure industries. 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 nine months ended September 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 and cash flows 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 nine months ended September 30, 2004 are not
necessarily indicative of the results to be expected for the full year. JMAR will continue to use cash in 2004 and into 2005
for 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 in Notes 9 and 10, management believes that the Company has
adequate resources to fund working capital requirements, product development
and
preferred stock redemptions, 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 and for working
capital requirements and for preferred stock redemptions beyond June 30, 5




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) 2005. As discussed below under
Commitments, the Company is obligated to make
redemption payments on its outstanding Series of Convertible Preferred Stock.
The Company has had discussions with the preferred stock holder regarding the
deferral of the redemption payments or the payment of the redemptions in common
stock of the Company. If the Company is unable to amend the redemption payment
terms and obtain additional financing, it would have to slow down its product
development, thereby impacting its commercialization plans. There can be no
assurance that additional financings will be available when needed, or if
available, will be done on favorable terms. (2) Recent Accounting Pronouncement 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 Plan). 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
    
    Nine Months Ended SeptemberSeptember 30,
    
    30,2004
    
    2003
    
    2004
    
    2003Loss applicable to
common stock:
    
    As Reported
    
    $
    (1,929,816
    )
    
    $
    (1,063,451
    )
    
    $
    (5,375,775
    )
    
    $
    (3,536,745
    )Stock based compensation expense, net of tax
    
    
    
    
    (212,580
    )
    
    
    (880,025
    )
    
    
    (559,739
    )
    
    
    (951,281
    )Pro Forma
    
    $
    (2,142,396
    )
    
    $
    (1,943,476
    )
    
    $
    (5,935,514
    )
    
    $
    (4,488,026
    )Basic and diluted loss per share:
    
    As Reported
    
    $
    (0.06
    )
    
    $
    (0.04
    )
    
    $
    (0.17
    )
    
    $
    (0.14
    )Pro Forma
    
    $
    (0.07
    )
    
    $
    (0.08
    )
    
    $
    (0.19
    )
    
    $
    (0.18
    )
 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 3.41
percent (2.74 percent in 2003); 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 142 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). No further
option grants are allowed under the 1991 Plan, Research Division 6




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) Plan or JPSI Plan. 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 equal to or more than
the stocks market price on date of grant for grants made during the three and
nine months ended September 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 nine months ended September 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
nine months ended September 30, 2004, 10,000 and 93,500 options, respectively,
were granted pursuant to the 1999 Plan. (4) Accounts Receivable At September 30, 2004 and December 31, 2003,
accounts receivable consisted
of the following: September 30, 2004
    
    December 31, 2003(Unaudited)Trade
    
    $
    365,571
    
    
    $
    546,505Trade  unbilled
    
    
    174,161
    
    
    
    108,800U.S. Government  billed
    
    
    2,095,731
    
    
    
    522,123U.S. Government  unbilled
    
    
    1,604,267
    
    
    
    1,624,597$
    4,239,730
    
    
    $
    2,802,025
 All unbilled receivables at September 30, 2004 are
expected to be billed
and collected within one year. Payments 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 $1,070,719 related to the
Companys contract with DARPA. The Company expects to receive
another $3.5 million in funding against its
DARPA contract. Of the
remaining balance of unbilled receivables, $348,167 is related to withheld fees
for prior contracts to be billed pending DCAA audit, and $359,542 is related to
the normal billing cycle. (5) Inventories Inventories are carried at the lower of cost (on the
first-in, first-out
basis) or market and are comprised of materials, direct labor and applicable
manufacturing overhead. At September 30, 2004 and December 31, 2003,
inventories consisted of the following: September 30, 2004
    
    December 31, 2003(Unaudited)Raw materials, components and sub-assemblies
    
    $
    50,000
    
    
    $
    214,694Work-in-process
    
    
    144,568
    
    
    
    87,981Finished goods
    
    
    1,153
    
    
    
    4,477$
    195,721
    
    
    $
    307,152
 (6) Property and Equipment At September 30, 2004 and December 31, 2003,
property and equipment
consisted of the following: September 30, 2004
    
    December 31, 2003(Unaudited)Equipment and machinery
    
    $
    3,080,842
    
    
    $
    2,774,470Furniture and fixtures
    
    
    440,992
    
    
    
    435,043Leasehold improvements
    
    
    283,218
    
    
    
    280,2833,805,052
    
    
    
    3,489,796Less-accumulated depreciation
    
    
    (2,915,400
    )
    
    
    (2,698,023
    )$
    889,652
    
    
    $
    791,773
 7




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) (7) Segment Information Through September 30, 2004 the Company has
operated 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 soft X-ray light point source, and its application for CPL X-ray
lithography, 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 nine months ended September 30, 2004 and 2003, this segment
accounted for approximately 40% and 33%, 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. Systems Division is partially funded by a
contract from DARPA. This contract supports Thin Film research and
demonstration using systems located at Systems Division and customer locations. Under this same contract, the division also
provides Zone Plate technology in support of Research Division X-ray
microscopy and X-ray nano probe technology. 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 nine months ended
September 30, 2004 and 2003, this segment accounted for approximately 27% and
41%, 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 nine months
ended September 30, 2004 and 2003, this segment accounted for approximately 33%
and 26%, 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 nine months ended
September 30, 2004
and 2003 (excluding discontinued operations) is as follows: Micro-Research
    
    Systems
    
    electronicsDivision
    
    Division
    
    Division
    
    Corporate
    
    TotalNine Months Ended September 30, 2004:Revenues
    
    $
    3,290,449
    
    
    $
    2,234,545
    
    
    $
    2,779,556
    
    
    $
    
    
    
    $
    8,304,550Operating loss
    
    
    (424,647
    )
    
    
    (1,494,455
    )
    
    
    (327,674
    )
    
    
    (586,626
    )
    
    
    (2,833,402
    )Asset write-down
    
    
    (85,313
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (85,313
    )Total assets
    
    
    4,879,660
    
    
    
    4,561,074
    
    
    
    1,640,290
    
    
    
    7,658,395
    
    
    
    18,739,419Goodwill
    
    
    
    
    
    
    4,415,932
    
    
    
    
    
    
    
    
    
    
    
    4,415,932Capital expenditures
    
    
    12,669
    
    
    
    7,922
    
    
    
    153,365
    
    
    
    141,300
    
    
    
    315,256Depreciation and amortization
    
    
    126,721
    
    
    
    169,154
    
    
    
    30,306
    
    
    
    522,753
    
    
    
    848,934Three Months Ended September 30, 2004:Revenues
    
    
    897,069
    
    
    
    537,272
    
    
    
    823,396
    
    
    
    
    
    
    
    2,257,737
 8




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##### Table of Contents



Micro-Research
    
    Systems
    
    electronicsDivision
    
    Division
    
    Division
    
    Corporate
    
    TotalOperating loss
    
    $
    (355,143
    )
    
    $
    (672,291

    )
    
    $
    (150,438
    )
    
    $
    (373,106
    )
    
    $
    (1,550,978
    )Asset write-down
    
    
    (35,737
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (35,737
    )Capital expenditures
    
    
    8,426
    
    
    
    
    
    
    
    126,626
    
    
    
    128,485
    
    
    
    263,537Depreciation and amortization
    
    
    44,421
    
    
    
    20,020
    
    
    
    15,964
    
    
    
    91,671
    
    
    
    172,076Nine Months Ended September 30, 2003:Revenues
    
    
    4,494,234
    
    
    
    5,619,409
    
    
    
    3,612,655
    
    
    
    
    
    
    
    13,726,298Operating income (loss)
    
    
    65,849
    
    
    
    (1,189,193
    )
    
    
    159,016
    
    
    
    (267,568
    )
    
    
    (1,231,896
    )Asset write-downs
    
    
    (306,149
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (306,149
    )Total assets
    
    
    2,775,678
    
    
    
    5,318,845
    
    
    
    1,289,918
    
    
    
    2,497,641
    
    
    
    11,882,082Goodwill
    
    
    
    
    
    
    3,790,907
    
    
    
    
    
    
    
    
    
    
    
    3,790,907Capital expenditures
    
    
    33,324
    
    
    
    2,578
    
    
    
    13,281
    
    
    
    7,881
    
    
    
    57,064Depreciation and amortization
    
    
    175,590
    
    
    
    236,831
    
    
    
    17,614
    
    
    
    253,519
    
    
    
    683,554Three Months Ended September 30, 2003:Revenues
    
    
    1,440,942
    
    
    
    1,520,045
    
    
    
    1,003,943
    
    
    
    
    
    
    
    3,964,930Operating income (loss)
    
    
    62,952
    
    
    
    (377,130
    )
    
    
    54,223
    
    
    
    (49,685
    )
    
    
    (309,640
    )Capital expenditures
    
    
    1,602
    
    
    
    
    
    
    
    2,562
    
    
    
    4,358
    
    
    
    8,522Depreciation and amortization
    
    
    58,096
    
    
    
    75,026
    
    
    
    6,729
    
    
    
    20,633
    
    
    
    160,484
 The asset write-down for 2004 of $85,313 relates to
patent costs. The
asset write-downs 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. The
operating loss for corporate was related to BioSentry in 2004 and
corporate general and administrative costs allocable to discontinued
operations in 2003. Sales to the United States Government totaled
$1,225,728, $4,724,439,
$2,685,466 and $9,143,922 for the three and nine months ended September 30,
2004 and 2003, respectively. In addition, sales to General Dynamics Advanced
Information Systems were $823,396, $2,773,502, $948,525 and $3,504,632 for the
three and nine months ended September 30, 2004 and 2003, respectively. (8) Discontinued Operations The loss from operations of discontinued operations of
$52,549 and $40,100
for the three and nine months ended September 30, 2004, respectively, is
related to the lease of the former facility of the standard semiconductor
products business. The loss from operations of discontinued operations of
$258,673 and $1,405,490 for the three and nine months ended September 30, 2003
includes $155,526 and $467,503, respectively, related to the standard
semiconductor products business and $103,147 and $937,987, respectively,
related to the precision equipment business. In July 2003, the Company sold
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 $50,000 in cash.
In addition, all JPSI receivables as of the closing were assigned to JMAR
Technologies, Inc. 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 in
the quarter ended June 30, 2004. 9




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) At September 30, 2004 and December 31, 2003,
net liabilities of assets
discontinued consisted of the following: September 30,
    
    December 31,2004
    
    2003(Unaudited)Current Liabilities:Facility lease accrual
    
    $
    216,846
    
    
    $
    598,466Accounts payable
    
    
    53,758
    
    
    
    230,978Employee related contractual
commitments
    
    
    
    
    
    
    10,384Note payable
    
    
    54,944
    
    
    
    121,155$
    325,548
    
    
    $
    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 nine months ended September 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 September 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 September 30, 2004, the unamortized discount and fees of $325,220
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 $65,094 and
$455,297 of interest expense for the three and nine months ending September 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 must be redeemed 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. The
Company made two monthly redemption payments during the three months ended
September 30, 2004 for a total of $166,667. Conversions to equity 10




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) are offset against the 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
must be redeemed 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 redeemed 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 November 8, 2004, the total outstanding
preferred stock, warrants
and Working Capital Line held by Laurus are convertible or exercisable into
approximately 4.2 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 of the preferred stock 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 unamortized
discount, including fees and costs, was
$1,158,623 at September 30, 2004. The following table summarizes the preferred stock
activity through
September 30, 2004. Nine Months Ended September 30, 2004FinancingBCF and Fair
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net Balance atNet Balance at
    
    
    
    
    
    Value of
    
    Fees and
    
    Discount
    
    
    
    
    
    
    
    
    
    September 30,Series
    
    December 31, 2003
    
    Gross Amount
    
    Warrants
    
    Costs
    
    Amortization
    
    Conversions
    
    Redemptions
    
    2004C
    
    $
    875,223
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    624,777
    
    
    $
    1.5M
    
    
    $
    
    
    
    $
    D
    
    
    1,341,927
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    658,073
    
    
    
    2.0M
    
    
    
    
    
    
    
    E
    
    
    
    
    
    
    1.5M
    
    
    
    600,061
    
    
    
    62,000
    
    
    
    248,273
    
    
    
    
    
    
    
    166,667
    
    
    
    919,545F
    
    
    
    
    
    
    2.0M
    
    
    
    207,422
    
    
    
    72,062
    
    
    
    57,671
    
    
    
    
    
    
    
    
    
    
    
    1,778,187G
    
    
    
    
    
    
    2.0M
    
    
    
    153,172
    
    
    
    72,062
    
    
    
    49,696
    
    
    
    
    
    
    
    
    
    
    
    1,824,462H
    
    
    
    
    
    
    4.0M
    
    
    
    306,343
    
    
    
    144,125
    
    
    
    102,984
    
    
    
    
    
    
    
    
    
    
    
    3,652,516$
    2,217,150
    
    
    $
    9.5M
    
    
    $
    1,266,998
    
    
    $
    350,249
    
    
    $
    1,741,474
    
    
    $
    3.5M
    
    
    $
    166,667
    
    
    $
    8,174,710
 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. 11




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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 nine months ending September 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 nine months ended September 30, 2004 and
2003, the Company issued 5,646 and 10,524 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 nine months ended September 30, 2004 and 2003 are
preferred stock dividends of $233,958, $1,938,339, $439,290 and $668,743,
respectively. The amount for the three and nine months ended September 30, 2004
represents $71,393 and $196,865, respectively, of preferred stock dividends
paid or payable in cash and $162,565 and $1,741,474, 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 three and nine months ended
September 30, 2003 represents $12,509 and $40,113, respectively, of preferred
stock dividends paid or payable in cash and $426,781 and $628,630,
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. If not previously converted, the Series E through
H Preferred Stock must
be redeemed as follows: GrossAmount
    
    Scheduled RedemptionsOutstanding atDescription
    
    September 30, 2004
    
    2004
    
    2005
    
    2006
    
    2007
    
    TotalSeries E Preferred
    
    $
    1.3M
    
    
    $
    250,000
    
    
    $
    1,000,000
    
    
    $
    83,333
    
    
    $
    
    
    
    $
    1,333,333Series 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$
    250,000
    
    
    $
    2,800,000
    
    
    $
    1,883,333
    
    
    $
    4,400,000
    
    
    $
    9,333,333
 In the three months ended September 30, 2004,
$166,667 of the Series E
Preferred was redeemed for cash. Under the Merger Agreement entered into in August, 2001
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 earn-out payments
upon the satisfaction of three earn-out conditions related to the development
and sale of CPL lithography systems. The first earn-out was not achieved and,
therefore, was not earned by the SAL investors. Based on the uncertainties of market acceptance of the
CPL technology and
delays in the completion of the CPL system, which operated to delay the
achievement of the second and third earn-outs, 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 earn-outs 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. Because of the uncertainty of whether or
not the earn-outs would be achieved, the Company believed that the current
situation was unsatisfactory for both JMAR and the Holders. Holders of more
than 99 percent of the earn-out interests 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 increased goodwill on the
accompanying Consolidated Balance Sheet for the quarter ended September 30,
2004. 12




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(Unaudited) (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 nine
months ended September 30, 2004 and 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 September 30, 2004 and 2003, the Company
had shares issuable under outstanding warrants, stock options, convertible debt
and convertible preferred stock of 8,098,810 and 7,824,029, 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 $4,415,932 and $3,790,907
at September 30, 2004 and December 31, 2003, respectively, is related to the
acquisition of SAL, Inc. in August, 2001. As of September 30, 2004, the
Company had the following amounts related to other intangible assets: Gross Carrying
    
    Accumulated
    
    Net IntangibleAmount
    
    Amortization
    
    AssetsPatents
    
    $
    969,942
    
    
    $
    483,636
    
    
    $
    486,306Licenses
    
    
    106,250
    
    
    
    5,760
    
    
    
    100,490$
    586,796
 Aggregate amortization expense of the intangible assets
with determinable
lives was $16,762 and $161,213 for the three and nine months ended September
30, 2004, respectively. The unamortized balance of intangible assets is
estimated to be amortized as follows: For the Year Ended
    
    Estimated AmortizationDecember 31,
    
    Expense2004
    
    $
    6,0122005
    
    
    28,0482006
    
    
    28,0482007
    
    
    28,0482008
    
    
    28,0482009
    
    
    28,048Beyond
    
    
    440,544$
    586,796
 (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, food and beverage and
homeland security markets. 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 September 30, 2004, the Company had provided approximately
$600,000 of financial support for costs incurred related to BioSentry, of which
$586,626 was expensed. The majority of the remainder of the $1 million
committed is expected to be provided by the Company by the end of 2004. The
alliance agreement also provided for execution of a purchase agreement after
achievement of certain development milestones. In September 2004, the Company
and LXT executed a definitive purchase agreement for the purchase by the
Company of the LXT business. The acquisition is expected to close in January
2005 after certain additional 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, 13




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




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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. is a leading innovator in the
development of
laser-based equipment for imaging, analysis and fabrication at the nano-scale.
The Company is leveraging over a decade of laser and photonics research to
develop a diverse portfolio of products with commercial applications in rapidly
growing industries while continuing to provide support for the U.S.
Governments Defense Microelectronics Activity (DMEA) semiconductor fabrication
facility. JMAR is targeting the nanotech, bioscience and semiconductor
industries with its Britelight laser; Compact X-ray Light Source; X-ray
Microscope  for 3D visualization of single cells and polymers; and its X-ray
Nano Probe  enabling interaction, analysis and modification at the nano-scale.
JMAR also maintains strategic alliances for the development of
BioSentry and
READ  biological and chemical sensors for homeland security, environmental and
utility infrastructure industries. 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 September 30,
2004, a total of $20.2 million has been received under this contract and the
Company expects to receive an additional $3.5 million in funding. 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 $3.5 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, and to produce Zone Plate optics for X-ray Microscopes and X-ray Nano
Probes (NAVAIR Contract). Through September 30, 2004, a total of $8.5 million
has been received under this contract. The Company expects to receive the
remaining funding of the Navair Contract and a new contract to further the work
in 2005. 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 and expects further funding in 2005. 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
drinking water, food and beverage 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,
JMAR designed, manufactured, and integrated two Alpha versions of the READ
sensor, a highly sensitive chemical detection system under contract for
FemtoTrace. JMAR expects to manufacture a number of Beta and initial
production units for FemtoTrace in 2005. 15




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##### Table of Contents



Products Under Development JMAR intends to balanceits government revenues
with commercial product
sales, expandits revenue base and earnings prospects by developing products
with the potential for large volume and attractive margins, and diversifyits
revenue stream by developing products of value to several high growth-rate
industries. BioSentry. JMAR is preparing to enter the drinking water, food and beverage and homeland security markets with a breakthrough
product for real-time, on-line detection and classification of microorganisms
in water. The BioSentry product has advanced from the proof of concept stage
to the Alpha model stage during the past three months. The Alpha model has
demonstrated reliable detection of several representative microorganisms and is
generating an enthusiastic reaction from prospective users. JMAR plans to put
Beta models in the field during the first quarter of 2005. Production
engineering and planning have started anticipating formal product roll-out and
production ramp-up by mid-2005. Compact X-Ray Microscope. Academic and industry
research centers engaged
in bioscience, medical research, advanced materials and chemistry represent an
attractive market for JMARs Compact X-Ray Microscope. Initial design
decisions have been made, and the preliminary design baseline for the product
has been established. Product roll-out is expected in 2006. X-Ray Nano Probe. The nanotechnology industry needs
instruments capable
of analysis and materials intervention at the nanoscale. JMAR is developing an
X-Ray Nano Probe with the potential for chemical analysis, deposition and
machining to a spot size as small as 20 nanometers. JMAR plans to position the
X-Ray Nano Probe as a basic instrument used in research, process development
and production of nanotechnology-based materials. Product roll-out is expected in 2006. Results of Operations Revenues. Total revenues for the three months
ended September 30, 2004 and 2003
were $2,257,737 and $3,964,930, respectively. Total revenues for the nine
months ended September 30, 2004 and 2003 were $8,304,550 and $13,726,298,
respectively. Revenues by segment for the three and nine months ended September
30, 2004 and 2003 were as follows: Three Months Ended September 30,
    
    Nine Months Ended September 30,2004
    
    2003
    
    2004
    
    2003Research Division
    
    $
    897,069
    
    
    $
    1,440,942
    
    
    $
    3,290,449
    
    
    $
    4,494,234Systems Division
    
    
    537,272
    
    
    
    1,520,045
    
    
    
    2,234,545
    
    
    
    5,619,409Microelectronics Division
    
    
    823,396
    
    
    
    1,003,943
    
    
    
    2,779,556
    
    
    
    3,612,655$
    2,257,737
    
    
    $
    3,964,930
    
    
    $
    8,304,550
    
    
    $
    13,726,298
 The decrease in revenues for the three and nine months
ended September 30,
2004 compared to the three and nine months ended September 30, 2003 was
primarily attributable to a decrease in the NAVAIR Contract revenues of
$628,819 and $2,478,275, respectively, at the Systems Division due to the delay
in receipt of funding on that contract, a decrease in revenues of the Research
and Systems Divisions related to the DARPA Contract of $950,665 and $1,625,837,
respectively, due to lower funding received on that contract, a decrease of
$138,565 and $925,923, respectively, related to two contracts at the Systems
Division that are nearing completion and a decrease in contract revenues at the
Microelectronics Division of $125,129 and $731,130, respectively, related to
reduced 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
September 30, 2004 and
2003 was $(1,695,858) and $(624,161), respectively. The loss from continuing
operations for those same periods was $(1,643,309) and $(570,488),
respectively, while the loss from operations for those same periods was
$(1,550,978) and $(309,640), respectively. The net loss for the nine months
ended September 30, 2004 and 2003 was 16




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##### Table of Contents



$(3,437,436) and $(2,868,002),
respectively. The loss from continuing
operations for those same periods was $(3,397,336) and $(1,667,512),
respectively, while the loss from operations for those same periods was
$(2,833,402) and $(1,231,896), respectively. Included in the net loss for the three and nine months
ended September 30,
2004 is a loss from discontinued operations of $52,549 and $40,100,
respectively. Included in the net loss and loss from operations for the three
and nine months ended September 30, 2004 are costs associated with the LXT
BioSentry development (see further discussion below) of $373,106 and $586,626,
respectively, and asset write-downs of $35,737 and $85,313, respectively.
Included in the net loss and loss from continuing operations for the three and
nine months ended September 30, 2004 is a non-cash interest charge of $100,706
and $571,214, respectively (see Interest and Other Expenses below). Included
in the net loss for the three and nine months ended September 30, 2003 is a
loss from discontinued operations of $(53,673) and $(1,200,490), respectively.
Included in the net loss and loss from operations for the nine months ended
September 30, 2003 are asset write downs of $306,149. Included in the net loss
and loss from continuing operations for the three and nine months ended
September 30, 2003 is a non-cash interest charge of $226,529 and $320,923,
respectively. Gross Margins. Gross margins for the nine months
ended September 30, 2004
and 2003 were 18.7% and 20.9%, respectively. Gross margins for the three months
ended September 30, 2004 and 2003 were 9.5% and 24.8%, 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 decrease in the gross margin for the three and nine
months ended September 30, 2004 compared to the three and nine months ended
September 30, 2003 is due to a contract reserve of $45,000 and $316,000 for the
three and nine months ended September 30, 2004, respectively, related to a
contract at the Systems Division and inventory reserves of approximately
$168,000 for the three and nine months ended September 30, 2004, also at the
Systems Division. These reductions were offset in part by 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 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 nine months ended September 30, 2004 due to lower
material costs in 2004 and a $70,000 contract cost overrun in 2003. 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. The Company is investing in new product development activities that it
believes will lead to higher margin products in the future. Selling, General and Administrative (SG&A).SG&A expenses for the nine
months ended September 30, 2004 and 2003 were $3,355,914 and $3,393,840,
respectively. SG&A expenses for the three months ended September 30, 2004 and
2003 were $1,070,065 and $1,116,762, respectively. The decrease in SG&A
expenses for 2004 was primarily attributable to a reduction in SG&A costs of
the Systems Division due to staff and other cost reductions, offset in part by
higher accounting, legal and insurance costs, and sales and marketing activity
and ISO costs at the Microelectronics Division. 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 $901,115 and $2,208,948 for the three months ended September 30, 2004
and 2003, respectively, and $3,625,837 and $7,750,712 for the nine month
periods ended September 30, 2004 and 2003. The decrease in customer-funded RD&E
expenditures for the three and nine months ended September 30, 2004 consists of
a decrease of $680,592 and $2,659,687, respectively, related to the Navair
Contract, decreases in two contracts winding down at the Systems Division of
$41,298 and $409,636, respectively, and a decrease of $585,943 and $1,055,552,
respectively, related to the DARPA Contract. Company-funded RD&E costs associated with product
development are shown in
Operating Expenses and totaled $286,889 and $176,100 for the three months
ended September 30, 2004 and 2003,
respectively, and $355,663 and $397,932 for the nine months ended September 30,
2004 and 2003, respectively. In addition, included in costs associated with
the BioSentry development are $227,901 and $353,039 of research and
development costs for the three and nine months ended September 30, 2004,
respectively. Hence, total RD&E expenditures for the three month periods were
$1,415,905 and $2,385,048 17




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for 2004 and 2003, respectively,
and $4,334,539 and $8,148,644 for the nine
month periods in 2004 and 2003. Total RD&E expenditures as a percentage of
revenues were 62.7% and 60.2% for the three months ended September 30, 2004 and
2003, respectively, and 52.2% and 59.4% for the nine months ended September 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 is using 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 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 Product
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, food and beverage and homeland security markets. 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
three and nine months ended September 30, 2004, the Company had expensed
$373,106 and $586,626, respectively, 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 loss from
discontinued operations of $52,549
and $40,100 for the three and nine months ended September 30, 2004,
respectively, is related to the standard semiconductor products business. The
loss from discontinued operations of $258,673 and $1,405,490 for the three and
nine months ended September 30, 2003, respectively, includes $155,526 and
$467,503, respectively, related to the standard semiconductor products business
and $103,147 and $937,987, respectively, related to the precision equipment
business. The decrease in the loss from discontinued operations is due to the
sale of JPSI in July 2003. The gain on disposal of discontinued
operations of
$205,000 for the three and nine months ended September 30, 2003 relates to the
sale of JPSI. 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 in
the quarter ended June 30, 2004. Interest and Other Expense.Interest and other
expense for the three
months ended September 30, 2004 and 2003 was $110,253 and $264,649,
respectively, and for the nine months ended September 30, 2004 and 2003 was
$675,364 and $495,475, respectively. Interest and other expense is higher for
the nine months ended September 30, 2004 versus the nine months ended September
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 nine months
ended September 30, 2004 is $65,094 and $455,297, respectively, and $180,826
and $187,935 for the three and nine months ended September 30, 2003,
respectively, related to the beneficial conversion feature and fair value of
warrants issued in connection with the Working Capital Line described below,
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 nine months ended September 30, 2004
and
2003 includes $35,612, $115,917, $45,703 and $132,988, 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 nine months ended September
30, 2004 and 2003 are preferred stock dividends 18




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##### Table of Contents



of $233,958, $1,938,339, $439,290
and $668,743, respectively. The amount for
the three and nine months ended September 30, 2004 represents $71,393 and
$196,865, respectively, of preferred stock dividends paid or payable in cash
and $162,565 and $1,741,474, 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 three and nine months ended September 30, 2003 represents
$12,509 and $40,113, respectively, of preferred stock dividends paid or payable
in cash and $426,781 and $628,630, 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. Consolidated Liquidity and Financial Condition Cash and cash equivalents at September 30, 2004
was $7,061,926. The
increase in cash and cash equivalents during the nine months ended September
30, 2004 of $2,890,747, resulted primarily from net proceeds from the issuance
of preferred and common stock of $9,057,914, offset in part by cash used in
continuing operations of $3,852,244 (primarily related to operating losses and
an increase in accounts receivable), payments of notes payable of $958,647,
cash used in discontinued operations of $675,535, capital expenditures of
$315,256, payment of preferred stock dividends of $196,865, and preferred stock
redemptions of $166,667. JMAR will continue to use cash in 2004 and into 2005
for, 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, product development and
preferred stock redemptions 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 and for working
capital requirements and preferred stock redemptions beyond June 30, 2005. As
discussed below under Commitments, the Company is obligated to make
redemption payments on its outstanding Series of Convertible Preferred Stock.
The Company has had discussions with the preferred stock holder regarding the
deferral of the redemption payments or the payment of the redemptions in common
stock of the Company. If the Company is unable to amend the redemption payment
terms and obtain additional financing, it would have to slow down its product
development, thereby impacting its commercialization plans. There can be no
assurance that additional financing will be available when needed, or if
available, will be done on favorable terms. Working capital as of September 30,
2004 and December 31, 2003 was $9,708,186 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 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
(4.75% at September 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 5.19 at
September 30, 2004. As of September 30, 2004, there was no amount outstanding
under the Working Capital Line. The term of the 19




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Working Capital Line runs until
March, 2006. The available borrowings under the
Working Capital Line were approximately $2.8 million at September 30, 2004, all
of which was unused at September 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
    
    
    
    Prime
    
    
    $
    3.11
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February, 2004
    
    
    G
    
    
    $
    2,000,000
    
    
    
    Prime
    
    
    $
    3.28
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February, 2004
    
    
    H
    
    
    $
    4,000,000
    
    
    
    Prime
    
    
    $
    3.47
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 The outstanding amount of Series E, F, G and H
Preferred Stock must be
redeemed 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. As of November 8, 2004, the
Company has redeemed $333,333 in Series E Preferred Stock. 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. The Companys stockholders equity was
$7,594,438 as of September 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. Commitments Future minimum annual commitments under non-cancellable
operating leases
(net of subleases), BioSentry development costs and post-employment benefits as
of September 30, 2004 are as follows (unaudited): 2004
    
    2005
    
    2006
    
    2007
    
    Thereafter
    
    TotalOperating leases
    
    $
    216,355
    
    
    $
    544,114
    
    
    $
    62,376
    
    
    $
    2,791
    
    
    $
    4,187
    
    
    $
    829,823BioSentry
development
    
    
    399,831
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    399,831Post-employment
benefits
    
    
    56,854
    
    
    
    282,377
    
    
    
    269,377
    
    
    
    269,377
    
    
    
    254,484
    
    
    
    1,132,469$
    673,040
    
    
    $
    826,491
    
    
    $
    331,753
    
    
    $
    272,168
    
    
    $
    258,671
    
    
    $
    2,362,123
 20




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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. Preferred Stock Redemption Obligations Excluded from the above table are redemption
obligations under Series E,
F, G and H Preferred Stock. Also excluded from the above table is the Companys
$3 million Working Capital Line, of which none was outstanding at September 30,
2004. If not previously converted, the Series E through H Preferred Stock must
be redeemed by the Company as follows: GrossAmount
    
    Scheduled RedemptionsOutstanding atDescription
    
    September 30, 2004
    
    2004
    
    2005
    
    2006
    
    2007
    
    TotalSeries E Preferred
    
    $
    1.3M
    
    
    $
    250,000
    
    
    $
    1,000,000
    
    
    $
    83,333
    
    
    $
    
    
    
    $
    1,333,333Series 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$
    250,000
    
    
    $
    2,800,000
    
    
    $
    1,883,333
    
    
    $
    4,400,000
    
    
    $
    9,333,333
 Resolution of SAL Earn-Outs Under the Merger Agreement entered into in August, 2001
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 earn-out payments
upon the satisfaction of three earn-out conditions related to the development
and sale of CPL lithography systems. The first earn-out was not achieved by the
deadline and, therefore, was not earned by the SAL investors. Based on the uncertainties of market acceptance of the
CPL technology and
delays in the completion of the CPL system, which operated to delay the
achievement of the second and third earn-outs, 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 earn-outs 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. Because of the uncertainty of whether or
not the earn-outs would be achieved, the Company believed that the current
situation was unsatisfactory for both JMAR and the Holders. Holders of more
than 99 percent of the earn-out interests 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. LXT Alliance Agreement (BioSentry) 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 drinking water, food and beverage and
homeland security markets. 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 September 30, 2004, the Company had provided approximately
$600,000 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 by the end of 2004. The alliance agreement also
provided for execution of a purchase agreement after achievement of certain
development milestones. In September 2004, the Company and LXT executed a
definitive purchase agreement for the purchase by the Company of the LXT
business. The acquisition is expected to close in January 2005 after certain
additional 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. 21




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Net Operating Loss Carryforward At December 31, 2003, the Company had
approximately $53 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 and stock based
compensation. Management bases its estimates and judgments on historical
experience and on various other factors that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. Management believes the
following critical accounting policies, among others, affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements. Revenues Product revenues are recognized when the product is
shipped FOB shipping
point, all risks of ownership have passed to the customer and the Company has
performed all obligations in accordance with Staff Accounting Bulletin No 101,
Revenue Recognition in Financial Statements (SAB No. 101). Contract revenues are recognized based on the
percentage of completion
method wherein income is recognized pro-rata over the life of the contract
based on the ratio of total incurred costs to anticipated total costs of the
contract. The program manager prepares a statement of work, schedule and
budget for each contract. At least monthly, actual costs are compared to budget
and technical progress is compared to the planned schedule. The Company
prepares an estimate of costs to complete for each contract at least quarterly.
Estimated losses based on this review 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. Capitalized patent costs 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 22




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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. 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 competitors with greater resources enter the markets
for the Companys new products;
    
    the risk that the technologies related to our new product development
activities may infringe on issued patents held by others;
    
    the effect of government regulations and required approvals on
the BioSentry and X-ray products; 23




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
    
    longer than anticipated purchase approval cycles and more extensive
selling efforts in connection with the sale of the Companys new
products to utilities and other regulated customers;
    
    the risk that the Company is subject to claims for product
liability arising from the sale of its new products and, specifically
with regard to its BioSentry system, that the Company is unable to
obtain adequate product liability insurance to cover these risks at a
reasonable cost, and that the Company is unable to obtain
indemnification agreements from its customers to hold the Company
harmless from such claims;
    
    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;
    
    unanticipated difficulties and costs in establishing the Companys
Vermont operations as the manufacturing center for the Companys new
products;
    
    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;
    
    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 September 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  changes in the
Companys internal control
over financial reporting during the quarter ended September 30, 2004 that have
materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting. 24




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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,
starting in 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.




PART II  OTHER INFORMATION




Item 2.Unregistered
Sales of Equity Securities and Use of Proceeds.

(a)(i) In July 2004, the Company granted warrants to purchase
50,000
shares to Dian Griesel, President of The Investor Relations Group, as
compensation for investor and public relations services. This transaction
was exempt under Section 4(2) of the Securities Act of 1933.

(a)(ii) In
August, 2004, the Company issued a total of 475,666 shares of Common
Stock to the former investors of SAL, Inc. in full satisfaction of
the earn-out rights previously issued to them in August, 2001 in a
transaction exempt under Section 4(2) of the Securities Act of 1933.




Item 5.Other
Information.

(a)
    
    On
August 13, 2004, the Compensation Committee of the Companys
Board of Directors approved the JMAR Balanced Scorecard Performance
Based Compensation Plan (the BSC Plan), a copy of which
is filed as Exhibit 10.1 to this Report and incorporated by reference
herein. All exempt employees of the Company will participate in the
BSC Plan. The BSC Plan provides for the payment of annual bonuses of
up to 10% of an employees base salary based upon the
establishment of specific corporate, division and individual goals.
The goals and objectives of the 2004 BSC Plan were established and
communicated to each eligible employee. The determination of the
extent to which these objectives have been realized, the amount of
the individual bonuses (less than or equal to 10% of the
individuals base salary) and the payment of such bonuses, if
any, will be made by management within 60 days after the end of the
calendar year.(b)
    
    On November 15, 2004, the Company filed an Amendment to
Certificate of Incorporation with the Delaware Secretary of State to
increase the authorized Common Stock from 40,000,000 shares to
80,000,000 shares, a copy of which is filed as Exhibit 10.2
to this Report. The form of this Amendment was filed with the
Companys Proxy Statement and the Amendment was approved by the
shareholders at the Companys Annual Shareholders Meeting held
June 25, 2004. 
 Item 6.Exhibits. Exhibit 10.1
    
    JMAR Balanced Scorecard
Performance Based Compensation Plan.Exhibit 10.2
    
    Amendment to Certificate of
Incorporation filed on November 15, 2004.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.
 25




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SIGNATURE Pursuant to the requirements of
the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. JMAR TECHNOLOGIES, INC.November 12, 2004By:
    
    /s/ Ronald A. WalrodRonald A. Walrod, Chief Executive Officer and Authorized OfficerBy:
    
    /s/ Dennis E. ValentineDennis E. Valentine, Chief Accounting Officer
 26