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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 March 31, 2005
Commission File Number 1-10515 JMAR TECHNOLOGIES, INC.   Delaware
    
    68-0131180(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. employer
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 þ 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 þ Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date (May 9, 2005). Common Stock, $.01 par value: 35,183,032 shares




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INDEX Page #PART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsConsolidated Balance Sheets - March 31, 2005 (unaudited) and December 31, 2004
    
    
    2Consolidated Statements of Operations (unaudited) - Three months ended March 31,2005 and 2004
    
    
    3Consolidated Statements of Cash Flows (unaudited) - Three months ended March 31,2005 and 2004
    
    
    4Notes to Consolidated Financial Statements (unaudited)
    
    
    5Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    25Item 4.
    
    Controls and Procedures
    
    
    25PART II.
    
    OTHER INFORMATIONItem 1.
    
    N/AItem 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    25Item 3.
    
    N/AItem 4.
    
    N/AItem 5.
    
    N/AItem 6.
    
    Exhibits
    
    
    26EXHIBIT 10.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
 1




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PART I  FINANCIAL INFORMATION JMAR TECHNOLOGIES, INC. 
 CONSOLIDATED BALANCE SHEETS
 As of March 31, 2005 and December 31, 2004
 March 31, 2005
    
    
    December 31, 2004(Unaudited)ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    9,873,339
    
    
    $
    6,599,588Accounts receivable
    
    
    1,611,795
    
    
    
    3,090,922Inventories
    
    
    227,968
    
    
    
    335,336Prepaid expenses and other
    
    
    599,319
    
    
    
    925,943Total current assets
    
    
    12,312,421
    
    
    
    10,951,789Property and equipment, net
    
    
    847,476
    
    
    
    879,012Intangible assets, net
    
    
    1,872,089
    
    
    
    537,191Other assets
    
    
    450,278
    
    
    
    642,174Goodwill
    
    
    4,415,932
    
    
    
    4,415,932TOTAL ASSETS
    
    $
    19,898,196
    
    
    $
    17,426,098LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    819,920
    
    
    $
    943,027Accrued liabilities
    
    
    270,102
    
    
    
    673,869Accrued payroll and related costs
    
    
    749,955
    
    
    
    731,718Billings in excess of costs incurred
    
    
    777,487
    
    
    
    861,383Current portion of notes payable and other liabilities
    
    
    151,930
    
    
    
    145,019Current liabilities of discontinued operations, including notes payable
    
    
    293,364
    
    
    
    416,391Total current liabilities
    
    
    3,062,758
    
    
    
    3,771,407Notes payable and other long-term liabilities, net of current portion
    
    
    440,465
    
    
    
    465,492Redeemable convertible preferred stock, 885,000 shares issued and outstanding
as of March 31, 2005 and 908,333 shares issued and outstanding as of December 31,
2004, net of unamortized discount of $1,811,398 and $996,059, respectively
    
    
    7,038,602
    
    
    
    8,087,274Stockholders equity:Preferred stock, $.01 par value; 5,000,000 shares authorized; 885,000 shares
issued and outstanding as of March 31, 2005 included in redeemable
convertible preferred stock above, and 908,333 shares
issued and outstanding as of December 31, 2004
    
    
    
    
    
    
    Common stock, $.01 par value; 80,000,000 shares authorized; 35,179,282
shares issued and outstanding as of March 31, 2005
and 31,376,735 shares issued and outstanding as of December 31,
2004
    
    
    351,793
    
    
    
    313,767Additional-paid in capital
    
    
    76,376,544
    
    
    
    70,087,057Accumulated deficit
    
    
    (67,371,966
    )
    
    
    (65,298,899
    )Total stockholders equity
    
    
    9,356,371
    
    
    
    5,101,925TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    19,898,196
    
    
    $
    17,426,098
 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 March 31, 2005 and 2004
(Unaudited)
 2005
    
    
    2004Revenues
    
    $
    1,867,331
    
    
    $
    3,035,376Costs of revenues
    
    
    1,306,875
    
    
    
    2,369,923Gross profit
    
    
    560,456
    
    
    
    665,453Operating expenses:Selling, general and administrative
    
    
    1,370,395
    
    
    
    1,125,774Research and development
    
    
    801,982
    
    
    
    54,097Total operating expenses
    
    
    2,172,377
    
    
    
    1,179,871Loss from operations
    
    
    (1,611,921
    )
    
    
    (514,418
    )Interest and other income
    
    
    37,291
    
    
    
    71,831Interest and other expense
    
    
    (116,819
    )
    
    
    (449,991
    )Loss from continuing operations
    
    
    (1,691,449
    )
    
    
    (892,578
    )Loss from operations of discontinued
operations
    
    
    
    
    
    
    (62,097
    )Net loss
    
    
    (1,691,449
    )
    
    
    (954,675
    )Deemed preferred stock dividends
    
    
    (381,618
    )
    
    
    (1,169,283
    )Loss applicable to common stock
    
    $
    (2,073,067
    )
    
    $
    (2,123,958
    )Basic and diluted loss per share:Loss per share from continuing
operations
    
    $
    (0.06
    )
    
    $
    (0.07
    )Loss per share from discontinued
operations
    
    
    
    
    
    
    Basic and diluted loss per share
applicable to common
stock
    
    $
    (0.06
    )
    
    $
    (0.07
    )Shares used in computation of basic and
diluted loss per share
    
    
    33,856,817
    
    
    
    29,660,437
 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 Three Months Ended March 31, 2005 and 2004
 (Unaudited)
 2005
    
    
    2004Cash flows from operating activities:Loss from continuing operations
    
    $
    (1,691,449
    )
    
    $
    (892,578
    )Adjustments to reconcile loss from continuing operations
to net cash used in continuing operations:Depreciation, amortization and debt discount
    
    
    158,025
    
    
    
    467,308Services received in exchange for common stock or warrants
    
    
    24,850
    
    
    
    Change in assets and liabilities:Accounts receivable
    
    
    1,479,127
    
    
    
    (978,250
    )Inventories
    
    
    107,368
    
    
    
    27,174Prepaid expenses and other
    
    
    433,076
    
    
    
    99,111Billings in excess of costs incurred
    
    
    (83,896
    )
    
    
    Accounts payable and accrued liabilities
    
    
    (473,104
    )
    
    
    (437,384
    )Net cash used in continuing operations operating activities
    
    
    (46,003
    )
    
    
    (1,714,619
    )Loss from discontinued operations
    
    
    
    
    
    
    (62,097
    )Changes in net assets and liabilities of discontinued operations
    
    
    (123,027
    )
    
    
    (300,273
    )Net cash used in discontinued operations
    
    
    (123,027
    )
    
    
    (362,370
    )Net cash used in operating activities
    
    
    (169,030
    )
    
    
    (2,076,989
    )Cash flows from investing activities:Capital expenditures
    
    
    (46,864
    )
    
    
    (19,011
    )Additions of intangible assets and other assets
    
    
    (1,163
    )
    
    
    (31,852
    )Net cash used in investing activities
    
    
    (48,027
    )
    
    
    (50,863
    )Cash flows from financing activities:Net proceeds from the issuance of preferred stock
    
    
    
    
    
    
    9,118,497Net proceeds from the issuance of common stock
    
    
    3,907,943
    
    
    
    Payments of notes payable and other long-term liabilities
    
    
    
    
    
    
    (835,761
    )Cash payments of preferred stock dividends
    
    
    (183,802
    )
    
    
    (59,258
    )Preferred stock redemptions
    
    
    (233,333
    )
    
    
    Net proceeds from the exercise of options
    
    
    
    
    
    
    82,191Net borrowings under line of credit
    
    
    
    
    
    
    123,161Repurchase of stock
    
    
    
    
    
    
    (17,747
    )Net cash provided by financing activities
    
    
    3,490,808
    
    
    
    8,411,083Net increase in cash and cash equivalents
    
    
    3,273,751
    
    
    
    6,283,231Cash and cash equivalents, beginning of period
    
    
    6,599,588
    
    
    
    4,171,179Cash and cash equivalents, end of period
    
    $
    9,873,339
    
    
    $
    10,454,410Cash paid for interest
    
    $
    39,293
    
    
    $
    48,366
 SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITY: During the three months ended March 31, 2005,
the Company recorded a discount of $1,066,803 representing the difference between the fair value of
the Convertible Preferred Stock immediately prior to and after the February 1, 2005 amendment (see
Note 10). In addition, during the three months ended March 31, 2005, the Company recorded
$1,348,266 for the fair value of license rights and certain assets acquired in connection with the
license agreement entered into with PointSource Technologies, LLC in January 2005 (see Note 12).
During the three months ended March 31, 2004, the holder of the Convertible Preferred Stock
converted $2,436,000 of the preferred stock into 1,321,154 shares of common stock of the Company.
The Company recorded a discount of $1,772,225 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 three months ended March 31, 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
three months ended March 31, 2004, the Company repaid $364,239 in convertible notes and $3,034 in
accrued interest with the issuance of 118,121 shares of common stock (see Note 9). The accompanying notes to
these consolidated financial statements are an integral part of these
consolidated statements. 4




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JMAR TECHNOLOGIES, INC.
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 (1) Basis of Presentation and Financial Condition The accompanying consolidated financial statements include the accounts of JMAR Technologies,
Inc. (the Company or JMAR) and its subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation. JMAR Technologies, Inc. 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 carry out research and development
for the U.S. Defense Advanced Research Projects Agency (DARPA) and support for the U.S.
Governments Defense Microelectronics Activity (DMEA) semiconductor fabrication facility. JMAR is
targeting the nanotechnology, bioscience and semiconductor industries with its
Britelight Laser; X-ray Light Source; Compact X-ray Microscope  for 3D
visualization of single cells and polymers; and its X-ray Nano Probe  enabling interaction,
analysis and materials modification at the nano-scale. JMAR also develops, manufactures and markets
its BioSentry microorganism early warning system and maintains a strategic alliance
for the production of the READ chemical sensor for homeland security, environmental and utility
infrastructure industries. The accompanying consolidated financial statements as of and for the three months ended March
31, 2005 and 2004 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, 2004. The results of operations for the three
months ended March 31, 2005 are not necessarily indicative of the results to be expected for the
full year. (2) Recent Accounting Pronouncements In December 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No.
123(R), Share-Based Payment, (SFAS No. 123(R)) which is a revision of SFAS No. 123. SFAS No.
123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB
Statement No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R) is similar
to the approach described in SFAS 123. However, SFAS No. 123(R) requires all share-based payments
to employees, including grants of employee stock options, to be recognized in the income statement
based on their fair values. Pro forma disclosure is no longer an alternative. SFAS No. 123(R) must
be adopted by the Company no later than January 1, 2006. Management is still evaluating the methodology to be used
and has not determined the impact on the Companys financial statements in the future. However,
based upon the proforma disclosures in Note 3, management anticipates that the impact could be as
much as $700,000 annually for currently outstanding options. In November 2004, the FASB issued FASB Statement No. 151, Inventory Costs, an amendment of
ARB No. 43, Chapter 4, which is effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. The amendments made by Statement 151 will improve financial
reporting by clarifying that abnormal amounts of idle facility expense, freight, handling costs,
and wasted materials (spoilage) should be recognized as current-period charges and by requiring the
allocation of fixed production overheads to 5




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued
(Unaudited) inventory based on the normal capacity of the production facilities. The Company does not
believe that the adoption of Statement 151 will have a significant effect on its financial
statements. (3) Stock-Based Compensation Plans The Company has five stock option plans, the 1991 Stock Option Plan (1991 Plan), the 1999
Stock Option Plan (1999 Plan), the Management Anti-Dilution Plan (Anti-Dilution Plan) and two
incentive plans which provided for the issuance of options to Research Division employees (Research
Division Plans). The Company is also a party to non-plan option 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 for issuance to employees. 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 for the three months ended March 31, 2005 and 2004 (unaudited): 2005
    
    
    2004Loss applicable to common stock:
    
    As Reported
    
    $
    (2,073,067
    )
    
    $
    (2,123,958
    )Stock based compensation expense
    
    
    
    
    
    
    (122,132
    )
    
    
    (165,676
    )Pro Forma
    
    $
    (2,195,199
    )
    
    $
    (2,289,634
    )Basic and diluted loss per share:
    
    As Reported
    
    $
    (0.06
    )
    
    $
    (0.07
    )Stock based compensation expense
    
    
    
    
    
    
    
    
    
    
    (0.01
    )Pro Forma
    
    $
    (0.06
    )
    
    $
    (0.08
    )
 The fair value of each option grant is estimated on the date of grant using the Black-Scholes
option pricing model with the following weighted-average assumptions used for grants in 2005 and
2004: risk-free interest rate of approximately 4.18 percent in 2005 and 2.74 percent in 2004;
expected dividend yields of 0 percent and expected lives of 6 years. For grants in 2005 and 2004,
the expected volatility used was 255 percent and 259 percent, respectively. The Company was authorized to grant options 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 and 350,000 shares under the Research Division Plans
(Plans). No further grants are allowed except under the 1999 Plan. In addition, 560,000
non-qualified options have been granted to three employees outside of the above plans. Except as
noted in the next sentence, under all Plans the option exercise price was equal to or more than the
market price of JMARs common stock on the date of grant for grants made during the three months
ended March 31, 2005 and 2004, and no compensation expense was recognized. Options for a total of
3,000 shares were granted to the Companys directors in payment of meeting fees in the three months
ended March 31, 2004, which had an exercise price of $1.00 below the market price resulting in
compensation expense of $3,000. Options typically have a term of ten years and vest one-third per
year after date of grant. During the quarter ended March 31,
2005 and 2004, 370,000 and 3,000
options, respectively, were granted pursuant to the 1999 Plan. (4) Accounts Receivable At March 31, 2005 and December 31, 2004, accounts receivable consisted of the following: March 31, 2005
    
    
    December 31, 2004(Unaudited)Billed
    
    $
    901,433
    
    
    $
    944,046Unbilled
    
    
    710,362
    
    
    
    2,146,876$
    1,611,795
    
    
    $
    3,090,922
 All unbilled receivables at March 31, 2005 are expected to be billed and collected within
one year. Payments to the Company for performance on certain U.S.
Government contracts are 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 at December 31, 2004 was $1,269,000
related to the Companys 6




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued
(Unaudited) contract with DARPA. In February 2005, DARPA released $3,508,000 in funds
related to the Companys
DARPA contract resulting in the billing and collection of the unbilled amount at December 31,
2004. The unbilled receivables at March 31, 2005 includes $348,171 related to withheld fees for
prior contracts to be billed pending DCAA audit, and $362,191 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 March 31, 2005
and December 31, 2004, inventories consisted of the following: March 31, 2005
    
    
    December 31, 2004(Unaudited)Raw materials, components and sub-assemblies
    
    $
    86,797
    
    
    $
    88,684Work-in-process
    
    
    140,017
    
    
    
    245,498Finished goods
    
    
    1,154
    
    
    
    1,154$
    227,968
    
    
    $
    335,336
 (6) Property and Equipment At March 31, 2005 and December 31, 2004, property and equipment consisted of the following: March 31, 2005
    
    
    December 31, 2004(Unaudited)Equipment and machinery
    
    $
    3,211,376
    
    
    $
    3,156,252Furniture and fixtures
    
    
    391,501
    
    
    
    440,990Leasehold improvements
    
    
    283,218
    
    
    
    283,2183,886,095
    
    
    
    3,880,460Less-accumulated depreciation
    
    
    (3,038,619
    )
    
    
    (3,001,448
    )$
    847,476
    
    
    $
    879,012
 (7) Segment Information JMAR conducts its operations in the following four business segments: Research Division (formerly JMAR Research)  Located in San Diego, California, this segment
carries out contract research and development involving JMARs patented high brightness,
short-pulse, diode pumped solid state lasers (Britelight) and laser-produced plasma (LPP)
technology. A major portion of the Research Divisions R&D has been funded by contracts from DARPA
of the U.S. Department of Defense. This segments historic focus on X-ray lithography light source
R&D and equipment development was expanded in 2004 when it embarked on an effort to identify
additional uses for its laser and LPP technologies. As a result of this business expansion
investigation, this segment is developing several soft X-ray enabled products including a Compact
X-ray Microscope and a family of instruments for nanotechnology applications. JMAR believes that
this instrument family will provide the ability to carry out chemical analysis, chemical vapor
deposition and erosion at resolutions down to 20 nm. During the three months ended March 31, 2005
and 2004, this segment accounted for approximately 26% and 37%, respectively, of the Companys
revenues. New products are developed at the Research Division based on contract and internally funded
R&D and then transitioned to JMARs Vermont Operations for product engineering and production. Vermont Operations (formerly JSAL)  Located in South Burlington, Vermont, this segment
carries out contract research and development involving nanolithography and serves as JMARs
manufacturing arm, carrying out the manufacturing engineering, production, integration and test of
JMARs new products. The Vermont Operations also applies its program management, engineering and
manufacturing expertise to the contract development and production of new products using the
customers technology. As an example, the 7




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued
(Unaudited) Vermont Operations is the design and manufacturing
contractor for FemtoTrace, Inc. building the READ trace
chemical sensors for real time detection of extremely small quantities of organics. The READ
equipment has applications in environmental contamination detection and homeland security. The
Vermont Operations will also introduce a novel Optical Angular Scanning Imaging System (OASIS) for
biological medical and materials research applications in 2005. OASIS is a versatile, rapid
scanning optical microscope that combines high magnification, fine optical resolution, and rapid
scanning motion control. This segment also performs funded contract research and development for
DARPA. During the three months ended March 31, 2005 and 2004, this segment accounted for
approximately 34% and 29%, respectively, of the Companys revenues. Microelectronics Division (formerly JMAR Semiconductor)  This segment provides process
integration and maintenance support to the Defense Microelectronics Activitys semiconductor
fabrication facility in McClellan, California. It also designs and produces application specific
integrated circuits (ASICs) for military and commercial markets and is developing application
specific standard products. During the three months ended March 31, 2005 and 2004, this segment
accounted for approximately 40% and 34% of the Companys revenues. Sensor Products Group  This segments first product is the BioSentry, a
laser-based early-warning system that provides continuous, real-time surveillance, detection and
classification of waterborne microorganisms. Prospective applications include beverage bottling
quality assurance, water utility operations, cruise ship water monitoring and homeland security for
building water supply and water distribution systems. During the three months ended March 31, 2005
and 2004, there were no revenues from this segment. Revenues are expected later in 2005. 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, 2004. 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 months ended March 31, 2005 and 2004 (excluding
discontinued operations) is as follows: SensorResearch
    
    
    Vermont
    
    
    Microelectronics
    
    
    ProductsDivision
    
    
    Operations
    
    
    Division
    
    
    Group
    
    
    Corporate
    
    
    Total2005Revenues
    
    $
    479,429
    
    
    $
    637,258
    
    
    $
    750,644
    
    
    $
    
    
    
    $
    
    
    
    $
    1,867,331Operating loss
    
    
    (446,375
    )
    
    
    (302,867
    )
    
    
    (346,149
    )
    
    
    (516,530
    )
    
    
    
    
    
    
    (1,611,921
    )Total assets
    
    
    1,710,870
    
    
    
    5,243,517
    
    
    
    2,259,145
    
    
    
    27,396
    
    
    
    10,657,268
    
    
    
    19,898,196Goodwill
    
    
    
    
    
    
    4,415,932
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,415,932Capital expenditures
    
    
    1,715
    
    
    
    
    
    
    
    
    
    
    
    1,517
    
    
    
    43,632
    
    
    
    46,864Depreciation & amortization
    
    
    24,812
    
    
    
    7,602
    
    
    
    23,933
    
    
    
    1,554
    
    
    
    100,124
    
    
    
    158,0252004Revenues
    
    
    1,103,807
    
    
    
    890,734
    
    
    
    1,040,835
    
    
    
    
    
    
    
    
    
    
    
    3,035,376Operating loss
    
    
    (69,575
    )
    
    
    (389,781
    )
    
    
    (55,062
    )
    
    
    
    
    
    
    
    
    
    
    (514,418
    )Total assets
    
    
    4,144,215
    
    
    
    4,698,097
    
    
    
    1,021,064
    
    
    
    
    
    
    
    11,054,857
    
    
    
    20,918,233Goodwill
    
    
    
    
    
    
    3,790,907
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,790,907Capital expenditures
    
    
    4,243
    
    
    
    2,849
    
    
    
    2,633
    
    
    
    
    
    
    
    9,286
    
    
    
    19,011Depreciation & amortization
    
    
    41,593
    
    
    
    74,034
    
    
    
    6,893
    
    
    
    
    
    
    
    344,788
    
    
    
    467,308
 Sales to the United States Government totaled $621,179 and $1,642,396 for the three months
ended March 31, 2005 and 2004, respectively. In addition, sales to General Dynamics Advanced
Information Systems were $750,644 and $1,034,781 for the three months ended March 31, 2005 and
2004, respectively. 8




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued
(Unaudited) (8) Discontinued Operations In the first quarter of 2002, the Company decided to discontinue its standard semiconductor
products business. Also, during the later half of 2002, the Company concluded that its precision
equipment business (JPSI) 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 JPSI and, in July 2003, the
Company completed the sale of that business. The standard semiconductor products business and JPSI have been accounted for in the
accompanying consolidated financial statements as discontinued operations. The loss from operations of discontinued operations of $62,097 for the three months ended
March 31, 2004 is related to imputed interest on the discounted value of the future lease payments
of the former facility of the standard semiconductor products business. 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 of $547,000
against the Irvine facility lease based on an appropriate discount rate and estimated sublease
rental income. 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 at a substantial reduction
from the Companys lease payment, however, the sub-tenant defaulted on the sublease in January
2005. At March 31, 2005 and December 31, 2004, net liabilities of assets discontinued consisted of
the following: March 31,
    
    
    December 31,2005
    
    
    2004(Unaudited)Current Liabilities:Facility lease accrual
    
    $
    165,917
    
    
    $
    275,221Accounts payable and accruals
    
    
    107,503
    
    
    
    103,726Note payable
    
    
    19,944
    
    
    
    37,444$
    293,364
    
    
    $
    416,391
 (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). As of March 31, 2005 there was no amount
outstanding under the Working Capital Line. 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 three months
ended March 31, 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). In connection with the Working Capital Line, the Company issued warrants to Laurus to purchase
100,000 shares of common stock in January 2004 at an exercise price of $5.15. For the January 2004 issuance, the Company recorded a discount of $254,691 representing the intrinsic value of the
beneficial conversion feature and a discount of $248,070, representing the fair value of the
100,000 warrants. The fair 9




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued
(Unaudited) value of each warrant grant is estimated on the date of issuance using the Black Scholes
pricing model with the following assumptions for the warrant issued in 2004: risk-free interest
rate of 2.7 percent; expected dividend yield of 0 percent; expected life of 7 years; and expected
volatility of 258 percent. At March 31, 2005, the unamortized discount and fees of $195,031 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 $324,105 of interest expense for the three months ending March 31, 2005 and 2004,
respectively. Also included in the discount are other fees paid to Laurus, including annual renewal
fees. In February 2004, the Company repaid convertible notes (SAL Notes) issued to the former
shareholders of SAL. The SAL Notes were repaid, including accrued interest, 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. The $3.11 per share value was calculated based on 85 percent of the 5
day average closing prices of the Companys stock prior to the last day for the SAL Noteholders to
accept the offer. This formula was based on negotiations between the Company and the Noteholders
representative. (10) Equity Transactions On February 1, 2005, the Company entered into a Securities Purchase Agreement and completed
the sale of $4 million of the Companys Common Stock and Warrants to five institutional investors
(Investors). Pursuant to the Securities Purchase Agreement, the Company issued a total of 3,225,807
shares of Common Stock at $1.24 per share and Warrants to purchase 1,209,679 shares of Common Stock
to the Investors. The Warrants have an exercise price of $1.73 per share and a term of five years.
After expenses of the transaction and the advisors fee, the Company received approximately
$3,852,000. In addition, on February 1, 2005, the Company entered into agreements with Laurus amending the
Companys Series E, F, G and H Convertible Preferred Stock (Amendments). The Amendments provide for
1) the deferral of approximately $3.8 million in monthly redemption payments, as follows: a)
payments of the remaining 12 months of redemption payments ($83,333 per month) for the Series E
Preferred Stock are deferred until July, 2006, and b) the next 18 months of redemption payments due
under the Series F, G and H Convertible Preferred Stock ($150,000 per month) are deferred until
February, 2007; 2) the grant of a right to the Company to elect to pay the originally scheduled
monthly redemption payments with shares of the Companys Common Stock valued at a 15% discount to
the then market price; and 3) the reduction in the conversion prices of the Series E-H Preferred
Stock (originally ranging from $2.85 to $3.47) to $2.00 per share. The monthly redemption payments
under the Series F-H Preferred Stock will recommence in August, 2006 until January, 2007, with the
balance of approximately $4.25 million in the stated amount of the Series F-H Preferred Stock due
in February, 2007. These redemption payments will be reduced to the extent that there are
conversions of the Preferred Stock into Common Stock. Also, in February 2005, certain investors purchased a total of 53,548 shares of Common Stock
at $1.24 per share and Warrants to purchase 20,081 shares of Common Stock with an exercise price of
$1.73 per share for a total purchase price of $66,400. As a result of the Amendment in February 2005, the Company recorded an additional discount
representing the difference between the fair value of the Preferred Stock immediately prior to and
after the Amendment of approximately $1.1 million valued based on the Black Scholes pricing model using the
following assumptions: risk-free interest rate of 3.23 percent based on estimated yields of 2-year
U.S. Treasury Securities; expected dividend yield of 0 percent; remaining contractual life of 2
years; and expected volatility of 108 percent. The volatility is based on JMARs historical stock
prices for the past two years, consistent with the remaining contractual life of the preferred
stock. This amount was recorded during the first quarter of fiscal year 2005 as a reduction of
preferred stock and will be amortized to preferred stock dividends over the earlier of the
redemption payment period or the conversion dates. 10




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued
(Unaudited) 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 conversion price of $2.85 per share (reduced to
$2.00 pursuant to the Amendment). In February 2004, the Company sold for cash $8 million of
Convertible Preferred Stock (Series F, G and H Preferred) to Laurus at a conversion price
of $3.11 to $3.47 per share (depending upon the Series), with an average conversion price of $3.34
per share (reduced to $2.00 pursuant to the Amendment). If not previously converted to common
stock, the Series E, F, G and H Preferred must be redeemed in cash (or it can be redeemed in 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). Conversions to equity are offset against the required repayments. Except for the conversion
price, the conversion terms of the Series E, F, G and H Preferred are the same as the conversion
terms of the Working Capital Line (see Note 9). If not previously converted, the Series E through H Preferred Stock, as amended, must be
redeemed by the Company as follows: GrossAmountOutstandingat March
    
    
    Scheduled RedemptionsDescription
    
    31, 2005
    
    
    2006
    
    
    2007
    
    
    TotalSeries E Preferred
    
    $
    1,000,000
    
    
    $
    1,000,000
    
    
    $
    
    
    
    $
    1,000,000Series F Preferred
    
    $
    1,962,500
    
    
    
    187,500
    
    
    
    1,775,000
    
    
    
    1,962,500Series G Preferred
    
    $
    1,962,500
    
    
    
    187,500
    
    
    
    1,775,000
    
    
    
    1,962,500Series H Preferred
    
    $
    3,925,000
    
    
    
    375,000
    
    
    
    3,550,000
    
    
    
    3,925,000$
    1,750,000
    
    
    $
    7,100,000
    
    
    $
    8,850,000
 In connection with all of the above financing transactions with Laurus, including related to
the Working Capital Line, 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 that is converted to equity up to a total of 50,000 shares.
As of May 9, 2005 all of the preferred stock, warrants and Working Capital Line held by Laurus is
convertible or exercisable into approximately 5.8 million shares. As a result of the convertible preferred stock and warrants issued in the three months ended
March 31, 2004, the Company recorded a discount representing the beneficial conversion feature and
the fair value of the warrants issued of approximately $1.3 million. The beneficial conversion
feature was recognized during the first quarter of fiscal year 2004 as a reduction of preferred
stock and is amortized to loss applicable to common stock over the earlier of the redemption period
or the conversion dates. The following table summarizes the preferred stock activity for the three months ended March
31, 2005. Net Balance at
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net BalanceDecember 31,
    
    
    Amendment Fair
    
    
    Discount
    
    
    
    
    
    
    at March 31,Series
    
    2004
    
    
    Value
    
    
    Amortization
    
    
    Redemptions
    
    
    2005E
    
    $
    752,306
    
    
    $
    79,390
    
    
    $
    89,374
    
    
    $
    83,333
    
    
    $
    678,957F
    
    
    1,812,092
    
    
    
    215,717
    
    
    
    40,527
    
    
    
    37,500
    
    
    
    1,599,402G
    
    
    1,844,699
    
    
    
    234,696
    
    
    
    38,194
    
    
    
    37,500
    
    
    
    1,610,697H
    
    
    3,678,177
    
    
    
    537,000
    
    
    
    83,369
    
    
    
    75,000
    
    
    
    3,149,546$
    8,087,274
    
    
    $
    1,066,803
    
    
    $
    251,464
    
    
    $
    233,333
    
    
    $
    7,038,602
 11




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued
(Unaudited) The following table summarizes the preferred stock activity for the three months ended
March 31, 2004. NetNet Balance at
    
    
    Financing
    
    
    

    
    
    
    

    
    
    Balance atDecember 31,
    
    
    Gross
    
    
    
    
    
    
    Fair Value of
    
    
    Fees and
    
    
    Discount
    
    
    
    
    
    
    March 31,Series
    
    2003
    
    
    Amount
    
    
    BCF
    
    
    Warrants
    
    
    Costs
    
    
    Amortization
    
    
    Conversions
    
    
    2004C
    
    $
    875,223
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    624,777
    
    
    $
    1,500,000
    
    
    $
    D
    
    
    1,341,927
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    356,627
    
    
    
    936,000
    
    
    
    762,554E
    
    
    
    
    
    
    1,500,000
    
    
    
    381,609
    
    
    
    218,451
    
    
    
    59,534
    
    
    
    82,758
    
    
    
    
    
    
    
    923,164F
    
    
    
    
    
    
    2,000,000
    
    
    
    54,250
    
    
    
    144,282
    
    
    
    72,062
    
    
    
    12,514
    
    
    
    
    
    
    
    1,741,920G
    
    
    
    
    
    
    2,000,000
    
    
    
    
    
    
    
    151,571
    
    
    
    72,062
    
    
    
    12,514
    
    
    
    
    
    
    
    1,788,881H
    
    
    
    
    
    
    4,000,000
    
    
    
    
    
    
    
    319,301
    
    
    
    144,125
    
    
    
    25,026
    
    
    
    
    
    
    
    3,561,600$
    2,217,150
    
    
    $
    9,500,000
    
    
    $
    435,859
    
    
    $
    833,605
    
    
    $
    347,783
    
    
    $
    1,114,216
    
    
    $
    2,436,000
    
    
    $
    8,778,119
 The fair value of each warrant grant for the three months ended March 31, 2004
was estimated on the date of issuance using the Black Scholes pricing model with the following
assumptions: risk-free interest rate of 2.7 percent; expected dividend yield of 0 percent; expected
life of 7 years; and expected volatility of 258 percent to 262 percent. No beneficial conversion
feature was recorded on the Series G and H preferred stock as the conversion price was higher than
the market price of the Companys common stock at the commitment date. All of the preferred stock, warrants and the Working Capital Line (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 commencing 75 days after notice of such
waiver. 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. During the three months ending March 31, 2004, the Company received proceeds of $82,191 for
the exercise of warrants and options into 38,267 shares of common stock. During the three months
ended March 31, 2005, the Company issued 3,192 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
months ended March 31, 2005 and 2004 are preferred stock dividends of $381,618 and $1,169,283,
respectively. The amounts for 2005 and 2004 represents $130,154 and $55,067, respectively, of
preferred stock dividends paid or payable in cash and $251,464 and $1,114,216, respectively,
related to the discount representing the beneficial conversion feature of the redeemable
convertible preferred stock, the fair value of warrants issued in connection with the preferred
stock and the difference between the fair value of the preferred stock immediately prior to and
after the Amendment. (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 months ended March 31, 2005 and 2004 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
March 31, 2005 and 2004, the Company had shares issuable under outstanding warrants, stock options,
convertible debt and convertible preferred stock 12




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued
(Unaudited) of 11,560,732 and 8,350,341, respectively, all of which are antidilutive and were excluded
from the computation of diluted loss per share. (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 at March 31, 2005 and December 31, 2004 is related to the acquisition of
SAL, Inc. in August, 2001. As of March 31, 2005 and December 31, 2004, the Company had the
following amounts related to other intangible assets: March 31, 2005
    
    
    December 31, 2004Gross
    
    
    
    
    
    
    Net
    
    
    Gross
    
    
    
    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Intangible
    
    
    Carrying
    
    
    Accumulated
    
    
    IntangibleAmount
    
    
    Amortization
    
    
    Assets
    
    
    Amount
    
    
    Amortization
    
    
    AssetsPatents
    
    $
    909,195
    
    
    $
    491,549
    
    
    $
    417,646
    
    
    $
    908,032
    
    
    $
    489,174
    
    
    $
    418,858Unpatented Technology
    
    
    450,000
    
    
    
    450,000
    
    
    
    
    
    
    
    450,000
    
    
    
    450,000
    
    
    
    Licenses
    
    
    1,464,516
    
    
    
    10,073
    
    
    
    1,454,443
    
    
    
    126,250
    
    
    
    7,917
    
    
    
    118,333$
    1,872,089
    
    
    
    
    
    
    
    
    
    
    $
    537,191
 During the three months ended March 31, 2005, the Company capitalized $1,163 related to patent
costs and $1,338,266 related to licenses. The Vermont Operations accounted for the patent costs,
while the Sensor Products Group accounted for the license costs (see below). In January 2005 the Company and PointSource Technologies, LLC (PointSource) entered into a
License Agreement granting JMAR an exclusive license covering all PointSource patents and other
intellectual property related to the manufacture and sale of scattered-radiation based products
used to detect or classify microorganisms in water and other media. As consideration for the
License Agreement, the Company issued 520,000 shares of common stock and Warrants to purchase
333,333 shares of common stock with an exercise price of $1.38 per share, and a term of 5 years.
The stock issued to PointSource was valued based on the market price of JMARs stock at the time
the agreement was consummated and the Warrants were valued based on the Black Scholes model using
the following assumptions: risk-free interest rate of 3.63 percent based on estimated yields of
5-year U.S. Treasury Securities; expected dividend yield of 0 percent; expected life of 5 years; and
expected volatility of 196 percent. The volatility is based on JMARs historical stock prices for
the past five years, consistent with the expected life of the Warrants. Aggregate amortization expense of the intangible assets with determinable lives was $4,531 and
$71,702 for the three months ended March 31, 2005 and 2004, respectively. The unamortized balance
of intangible assets is estimated to be amortized as follows: Estimated AmortizationFor the Year Ended December 31,
    
    Expense2005
    
    $
    204,9472006
    
    
    443,3712007
    
    
    443,3712008
    
    
    443,3712009
    
    
    101,0242010
    
    
    69,901Beyond
    
    
    166,104$
    1,872,089
 13




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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 carry out research and development
for the U.S. Defense Advanced Research Projects Agency (DARPA) and support for the U.S.
Governments Defense Microelectronics Activity (DMEA) semiconductor fabrication facility. JMAR is
targeting the nanotechnology, bioscience and semiconductor industries with its
Britelight Laser; X-ray Light Source; Compact X-ray Microscope  for 3D
visualization of single cells and polymers; and its X-ray Nano Probe  enabling interaction,
analysis and materials modification at the nano-scale. JMAR also develops, manufactures and markets
its BioSentry microorganism early warning system and maintains a strategic alliance
for the production of the READ chemical sensor for homeland security, environmental and utility
infrastructure industries. Sources of Revenue Currently, the majority of the Companys revenues are derived as the prime contractor or
subcontractor for government contracts. These contracts have generated intellectual property owned
by the Company in areas in which the Company
believes there are significant commercial applications. 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
Collimated Plasma Lithography (CPL) system (DARPA Contract). A total of $23.7 million has been
funded under this contract, including $3.5 million funded in February 2005 (the receipt of funding
allows the Company to bill for costs incurred). No program funding related to the DARPA Contract is
included in the United States Governments fiscal year budget and the Company expects no further
funding under this contract. JMARs next most significant contract is a $10 million contract issued to JMARs Vermont
Operations by Naval Air Warfare Center AD to procure sub-100 nm feature size X-ray masks used in
the development and production of high performance GaAs MMICs and to produce zone plate optics
(NAVAIR Contract). Through March 31, 2005, a total of $8.8 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 $3.5 million in contracts in
2004 for this program. Unrelated to JMARs Britelight and X-ray source technology, we are preparing to enter the
drinking water, food and beverage and homeland security markets with our new
BioSentry sensor product. The BioSentry sensor provides continuous
monitoring of drinking water for microorganisms. This product has successfully passed proof of
concept testing and we have assembled Beta units for installation at various Beta sites in the
first and second quarters of 2005. In early March 2005, we entered into a Technology Testing and
Contingent Purchase Agreement with Olivenhain Municipal Water District (OMWD) which provides for
the installation and testing of three Beta models of the BioSentry sensor at OMWDs water treatment
plant in San Diego County. If the BioSentry Beta units satisfy certain test criteria during a six
month test period, including approval by the state regulator, OMWD has agreed to purchase three
production units. We installed the first Beta test units at OMWD shortly before the end of the
first quarter of 2005. In addition, in April 2005, we entered into a contract with Mexicos leading
beverage development and manufacturing company (Kimpen S.A. de C.V. (Kimpen)) to install a
pre-production model of the BioSentry at Kimpens laboratory facility and then, following
successful completion of an agreed test plan, Kimpen has agreed to purchase two BioSentry
production systems for installation in two of Kimpens production facilities. Following 14




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##### Table of Contents



successful operational testing, Kimpen will purchase 15 production units for installation at
each of its 15 factories. Through our collaboration with FemtoTrace, Inc., JMAR has designed, manufactured, and
integrated two Alpha versions of the READ sensor, a highly sensitive chemical detection system
under contract for FemtoTrace. JMARs contract with FemtoTrace provides for the manufacture of a
number of Beta units for FemtoTrace in 2005. JMAR is also discussing the terms of an agreement to
act as contract manufacturer for the production units of FemtoTraces READ sensor product line. With the future prospects of its CPL product development program uncertain and with the
benefit of a substantial investment in intellectual property related to soft X-ray generation, in
2004 JMAR implemented a new strategy to balance, diversify and expand its revenue base through new
product development and technology acquisition. We are now complementing our progress in product
development and market validation with preparation for manufacturing and distribution. In pursuit
of this new strategy, JMAR has identified other, more immediate, commercial opportunities for our
laser and X-ray technology, namely our Compact X-ray Microscope and X-ray Nano Probe products. JMAR
has also acquired new technology in multi-angle light scattering and is developing BioSentry
products we plan to deliver in 2005 to several high growth-rate industries. JMAR intends to
continue to pursue government funding in areas that create valuable technology to support its new
product development efforts. As JMAR seeks to add commercial revenues to our predominately government contract revenue
base, we face a series of challenges, including technical and market risks and uncertainties
associated with the development of new technologies and new products. Our product development
efforts will require substantial continued investment by JMAR and we expect to face challenges in
transitioning each of our new products from the proof of concept, alpha and beta stages to
commercial introduction and market acceptance. See Safe Harbor Statement under the Private
Securities Litigation Reform Act of 1995 below for more information on the risks and uncertainties
faced by JMAR. Results of Operations Revenues. Total revenues for the three months ended March 31, 2005 and 2004 were $1,867,331
and $3,035,376, respectively, the majority of which were contract revenues. Revenues by segment for
the three months ended March 31, 2005 and 2004 were as follows: 2005
    
    
    2004Research Division
    
    $
    479,429
    
    
    $
    1,103,807Vermont Operations
    
    
    637,258
    
    
    
    890,734Microelectronics Division
    
    
    750,644
    
    
    
    1,040,835Sensor Products Group
    
    
    
    
    
    
    $
    1,867,331
    
    
    $
    3,035,376
 The decrease in revenues for the three months ended March 31, 2005 compared to the three
months ended March 31, 2004 was primarily attributable to a decrease of $1,391,880 in revenues of
the Research Division and Vermont Operations related to the DARPA Contract, a decrease of $284,137
in contract revenues at the Microelectronics Division related to reduced equipment installations
under the GDAIS Contract in 2005, and a decrease of $136,844 in revenues for the READ contract. The
lower revenues for the DARPA Contract in 2005 is related to the fact that no additional program
funding related to the DARPA Contract was included in the U.S. Government fiscal year 2005 budget
and no further funding under this contract is expected beyond the funds received in February 2005.
Offsetting these declines were an increase of $406,383 in revenues of the NAVAIR Contract due to
funding received later in 2004 and the sale in the amount of $350,000 of a Britelight system to
Lawrence Livermore National Laboratories. The Company will continue to experience flat or lower
revenues for 2005 compared to 2004 until sales from our new products are realized. 15




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Losses. The net loss for the three months ended March 31, 2005 and 2004 was $(1,691,449) and
$(954,675), respectively. The loss from continuing operations for those same periods was
$(1,691,449) and $(892,578), respectively, while the loss from operations for those same periods
was $(1,611,921) and $(514,418), respectively. Included in the net loss for the three months ended
March 31, 2004 is a loss from discontinued operations of $(62,097). Included in the net loss and
loss from operations for the three months ended March 31, 2005 and 2004 are costs associated with
product development (see further discussion below) of $801,982 and $54,097, respectively. Also
included in the net loss and loss from continuing operations for the three months ended March 31,
2005 and 2004 is a non-cash interest charge of $65,094 and $324,105, respectively (see Interest
and Other Expenses below). Gross Margins. Gross margins for the three months ended March 31, 2005 and 2004 were 30.0% and
21.9%, respectively. The Companys margins are low because the majority of its revenues are from
contract revenues, which inherently generate lower margins than product revenues. The primary
increase in the gross margin for the three months ended March 31, 2005 compared to the three months
ended March 31, 2004 is due to the commercial sale in 2005 of a Britelight system by the Research
Division. In addition, the Company recorded a contract reserve of approximately $171,000 in 2004
related to reserves on a contract at the Vermont Operations. Negatively impacting the gross margin
in 2005 compared to 2004 was lower margins because of fixed cost absorption at the Vermont
Operations due to the lower revenues. The majority of the Companys revenues for 2005 will be
derived from contracts, so gross margins are expected to continue at similar levels as in 2004
increased somewhat by higher gross margins expected later in 2005 from sales of BioSentry and
Britelight products. 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 three months ended March 31,
2005 and 2004 were $1,370,395 and $1,125,774, respectively. The increase in SG&A expenses in 2005
compared to 2004 was primarily attributable to SG&A costs of the Sensor Products Group formed later
in 2004 of $289,381 and higher outside accounting fees of approximately $43,000. These increases were offset in
part by a reduction of costs at the Vermont Operations due to staff and other cost reductions of
$125,969. 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, primarily related to the DARPA Contract and the
NAVAIR Contract, are included in Costs of Revenues, and totaled $450,081 and $1,330,682
for the three months ended March 31, 2005 and 2004, respectively. The decrease in
customer-funded RD&E expenditures for the three months ended March 31, 2005 consists of a
decrease of $956,857 related to the DARPA Contract and decreases in two contracts completed
in 2004 at the Vermont Operations of $219,703. These decreases were offset in part by an
increase of $295,959 related to the NAVAIR Contract.
    Company-funded RD&E costs associated with product development are shown in Operating
Expenses and totaled $801,982 and $54,097 for the three months ended March 31, 2005 and
2004, respectively. The increase in 2005 is primarily due to product development started
later in 2004 for our XRM, XNP, BioSentry and OASIS new products. Total RD&E expenditures for the three month periods were $1,252,063 and $1,384,779 for 2005
and 2004, respectively. Total RD&E expenditures as a percentage of revenues were 67.1% and 45.6%
for the three months ended March 31, 2005 and 2004, respectively. 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. During
2004 and 2005, JMAR has been implementing its strategy to balance, diversify and expand its
revenue base through new product development 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 initiated the
product development of the X-ray 16




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Microscope and X-ray Nano Probe product lines. Accordingly, the Company expects company-funded
RD&E to increase significantly for 2005 compared to early 2004. Discontinued Operations.The loss from operations of discontinued operations of $62,097 for
the three months ended March 31, 2004 is related to the standard semiconductor products business,
primarily associated with the lease of the Irvine facility. Prior to December 31, 2001, as the
level of business expected from its standard semiconductor products business did not materialize,
the Company decided to take action to sublease its 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, however, the sub-tenant
defaulted on the sublease in January 2005 and the facility is currently unoccupied. Interest and Other Expense.Interest and other expense for the three months ended March 31,
2005 and 2004 was $116,819 and $449,991, respectively. Interest and other expense is lower for 2005
versus 2004 primarily due to conversions of the Companys Working Capital Line into common stock in
2004 which resulted in an acceleration of amortization of the discount related to the beneficial
conversion feature and fair value of warrants issued in connection with the Working Capital Line.
Included in interest expense for the three months ended March 31, 2005 and 2004 is $65,094 and
$324,105 related to the beneficial conversion feature and fair value of warrants issued in
connection with the Working Capital Line described below. These amounts were charged to expense
using the effective yield method over the period from the issuance date to the earlier of the
maturity date of the debt or the conversion dates. Interest expense for the three months ended
March 31, 2005 and 2004 also includes $33,307 and $43,750, respectively, related to the discounted
liability for deferred compensation. Preferred Stock Dividends.Included in the loss applicable to common stock in the Statement of
Operations for the three months ended March 31, 2005 and 2004 are preferred stock dividends of
$381,618 and $1,169,283, respectively. Preferred stock dividends are lower for 2005 versus 2004 due
to conversions of preferred stock into common stock in 2004 which resulted in an acceleration of
amortization of the discount related to the beneficial conversion feature and fair value of
warrants issued in connection with the preferred stock. The amounts for 2005 and 2004 represents
$130,154 and $55,067, respectively, of preferred stock dividends paid or payable in cash and
$251,464 and $1,114,216, 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 General.Cash and cash equivalents at March 31, 2005 was $9,873,339. In 2005 and 2004, we have
funded our operations primarily from the sale of preferred and common stock. The increase in cash
and cash equivalents during the three months ended March 31, 2005 of $3,273,751 resulted primarily
from net proceeds from the issuance of common stock of $3,907,943, offset in part by preferred
stock redemptions of $233,333, cash used in continuing operations of
$46,003 (primarily related to
operating losses and a reduction in liabilities offset in part by a reduction in accounts
receivable), payment of preferred stock dividends of $183,802, cash used in discontinued operations
of $123,027 and capital expenditures of $46,864. JMARs operations will continue to use cash in 2005 for 1) product research and development
efforts and to acquire or license products, technologies or businesses; 2) corporate costs,
primarily related to the cost of being a public company; 3) preferred stock dividends; and 4) 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 and product
development at least through March 31, 2006. Working capital as of March 31, 2005 and December 31,
2004 was $9,249,663 and $7,180,382, respectively. The increase in working capital is primarily due
to gross proceeds from the issuance of common stock of approximately $4.1 million offset in part by
the Companys losses, preferred stock redemptions and payment of preferred stock dividends. Sale of Common Stock. On February 1, 2005, the Company entered into a Securities Purchase
Agreement and completed the sale of $4 million of the Companys Common Stock and Warrants to five 17




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institutional investors (Investors). Pursuant to the Securities Purchase Agreement, the Company
issued a total of 3,225,807 shares of Common Stock and Warrants to purchase 1,209,679 shares of
Common Stock to the Investors. The Warrants have an exercise price of $1.73 per share and a term of
five years. After expenses of the transaction and the advisors fee, the Company received net
proceeds of approximately $3,852,000. As a result of the completion of the February 2005 Offering, the PointSource Investors (see
PointSource License Agreement, below) were offered the right to purchase a total of 53,548 shares
of Common Stock (Additional Shares) and Warrants to purchase 20,081 shares of Common Stock with an
exercise price of $1.73 per share (Additional Warrants) for a total purchase price of $66,400. In
mid-February, 2005, the PointSource Investors purchased the Additional Shares and Additional
Warrants for $66,400. Issuances of Preferred Stock.In 2004, the Company sold the following series of Preferred
Stock to Laurus for cash: ConversionIssuance Date
    
    Series
    
    Amount
    
    Dividend
    
    PriceJanuary, 2004
    
    E
    
    $1,500,000
    
    8%
    
    $2.85(1)February, 2004
    
    F
    
    $2,000,000
    
    Prime (2)
    
    $3.11(1)February, 2004
    
    G
    
    $2,000,000
    
    Prime (2)
    
    $3.28(1)February, 2004
    
    H
    
    $4,000,000
    
    Prime (2)
    
    $3.47(1)
   (1)
    
    Reduced to $2.00 pursuant to February 1, 2005 agreement (see below)(2)
    
    Prime rate at March 31, 2005 was 5.75 percent If not previously converted to common stock, the outstanding amount of Series E, F, G and H
Preferred Stock must be redeemed in cash (or it could be redeemed with 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). 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 (see below). On February 1, 2005, the Company entered into agreements with Laurus to amend the Companys
Series E, F, G and H Convertible Preferred Stock (Amendments). The Amendments provide for 1) the
deferral of approximately $3.8 million in monthly redemption payments, as follows: a) payments of
the remaining 12 months of redemption payments ($83,333 per month) for the Series E Preferred Stock
are deferred until July 2006, and b) the next 18 months of redemption payments due under the Series
F, G and H Convertible Preferred Stock ($150,000 per month) are deferred until February 2007; 2)
the grant of a right to the Company to elect to pay the originally scheduled monthly redemption
payments with shares of the Companys Common Stock valued at a 15% discount to the then market
price; and 3) the reduction in the conversion prices of the Series E-H Preferred Stock (originally
ranging from $2.85 to $3.47) to $2.00 per share. The monthly redemption payments under the Series
F-H Preferred Stock will recommence in August, 2006 until January 2007, with the balance of
approximately $4.25 million in the stated amount of the Series F-H Preferred Stock due in February
2007. These redemption payments will be reduced to the extent that there are conversions of the
Preferred Stock into Common Stock. In connection with all of the financing transactions with Laurus (Working Capital Line and
Series A-H Preferred Stock Issuances), 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 that is converted to equity up to a total of 50,000
shares. 18




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##### Table of Contents



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. Working Capital Line.In March 2003, the Company entered into a Revolving Fixed Price
Convertible Note (Working Capital Line) with Laurus. As of March 31, 2005, there was no amount
outstanding under the Working Capital Line. 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 (5.75% at March 31,
2005) 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 4.15 at March 31, 2005. The term of the Working Capital Line runs until March, 2006. The
available borrowings under the Working Capital Line were approximately $1.1 million at March 31,
2005, all of which was unused at March 31, 2005. Cash
Used in Continuing Operations. Cash used in continuing operations
was $46,003 for the
three months ended March 31, 2005 compared to $1,714,619 for the three months ended March 31, 2004.
The loss from continuing operations net of non-cash items (depreciation, amortization, debt
discount and services received in exchange for common stock or warrants) was $1,508,574 and
$425,270 for the three months ended March 31, 2005 and 2004, respectively. The higher use of cash
related to the loss from continuing operations net of non-cash items in 2005 is primarily due to higher product development costs in 2005
compared to 2004 of $747,885, higher SG&A costs of $244,621 and lower revenues resulting in a lower
gross profit in 2005 compared to 2004 of $104,997. The Company will continue to experience flat or
lower revenues for 2005 compared to 2004 until sales from our new products are realized. In
addition, product development expenditures are expected to increase significantly for 2005 compared
to early 2004. Helping cash flow from operations for the three months ended March 31, 2005 was a
reduction in accounts receivable of $1,479,127 primarily related to the receipt of $3,508,000 in
funding on the DARPA Contract in February 2005. Accounts receivable increased by $978,250 in the
three months ended March 31, 2004 primarily related to funding delays on the DARPA Contract. In
addition, accounts payable and accrued liabilities decreased by $437,384 in 2004 primarily because
of the Companys better liquidity position as a result of the financings in January and February
2004. Cash Used in Discontinued Operations. For the three months ended March 31, 2005, cash used in
discontinued operations was $123,027 compared to $362,370 for the three months ended March 31,
2004. Cash used in 2005 primarily related to payments related to the Irvine facility. Cash used in
2004 included non-cash losses of $16,639, payments related to the Irvine facility of $106,119,
payment of $137,500 to a creditor of the discontinued standard chip business, payments related to
JPSIs facility of $59,665 and other payments of $42,447. The Company expects cash required for
discontinued operations to continue to decline in 2005 compared to 2004 to approximately $200,000
for the remainder of 2005, primarily related to the payment of the remaining lease payments for the
Irvine facility. Cash Used in Investing Activities. For the three months ended March 31, 2005, cash used in
investing activities, primarily capital expenditures, was $48,027 compared to $50,863 for the three
months ended March 31, 2004. The Company expects an increase in capital expenditures later in 2005
primarily related to the ramp-up of manufacturing at the Vermont Operations and consolidation and
expansion of its three San Diego facilities into one location. Cash Provided by Financing Activities. For the three months ended March 31, 2005, cash
provided by financing activities was $3,490,808 compared to $8,411,083 for the three months ended
March 31, 2004. Net 19




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##### Table of Contents



proceeds from the sale of common stock were $3,907,943 in 2005. Net proceeds
from the sale of preferred stock were $9,118,497 in 2004. During 2005, the Company made preferred
stock redemptions of $233,333 (see preferred stock Amendments discussed above). Preferred stock
dividends in 2005 and 2004 were $183,802 and $59,258, respectively. In 2004, the Company made note
payments of $835,761 related to the SAL Notes (see Note 9 to Financial Statements). Stockholders Equity.The Companys stockholders equity was $9,356,371 as of March 31, 2005.
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. 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 contractual obligations, net of sublease income, and
deferred compensation as of March 31, 2005 are as follows (2005 is for nine months) (unaudited): 2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    TotalLeases
    
    $
    573,022
    
    
    $
    130,203
    
    
    $
    11,361
    
    
    $
    11,361
    
    
    $
    3,787
    
    
    $
    729,734Deferred
compensation
    
    
    231,443
    
    
    
    267,175
    
    
    
    275,297
    
    
    
    185,955
    
    
    
    56,003
    
    
    
    1,015,873$
    804,465
    
    
    $
    397,378
    
    
    $
    286,658
    
    
    $
    197,316
    
    
    $
    59,790
    
    
    $
    1,745,607
 The leases are primarily for office facilities. The deferred compensation is presented at
the total amount to be paid, whereas the liability has been discounted for financial reporting
purposes. Several of the Companys San Diego County facility leases are expiring through April 30,
2006 and the Company expects to enter into a new multi-year lease in the next several months in
connection with the consolidation of its San Diego County operations into a single facility. Preferred Stock Redemption Obligations Excluded from the above table are redemption obligations under Series E, F, G and H Preferred
Stock, as amended on February 1, 2005. Also excluded from the above table is the Companys $3
million Working Capital Line, as to which no amounts were outstanding at March 31, 2005. If not
previously converted, the Series E through H Preferred Stock, as amended, must be redeemed by the
Company as follows: GrossAmountOutstandingat March
    
    
    Scheduled RedemptionsDescription
    
    31, 2005
    
    
    2006
    
    
    2007
    
    
    TotalSeries E Preferred
    
    $
    1,000,000
    
    
    $
    1,000,000
    
    
    $
    
    
    
    $
    1,000,000Series F Preferred
    
    $
    1,962,500
    
    
    
    187,500
    
    
    
    1,775,000
    
    

    
    1,962,500Series G Preferred
    
    $
    1,962,500
    
    
    
    187,500
    
    
    
    1,775,000
    
    
    
    1,962,500Series H Preferred
    
    $
    3,925,000
    
    
    
    375,000
    
    
    
    3,550,000
    
    
    
    3,925,000$
    1,750,000
    
    
    $
    7,100,000
    
    
    $
    8,850,000
 PointSource License Agreement In January 2005, JMAR and PointSource Technologies, LLC (PointSource) entered into a License
Agreement granting the Company an exclusive license covering all PointSource patents and other
intellectual property related to the manufacture and sale of scattered-radiation based products
used to detect or classify 20




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microorganisms in water and other media. This technology is directly
relevant to and may be used in JMARs new BioSentry product. Pursuant to the License Agreement,
PointSource also sold substantially all of its laboratory and engineering room equipment to the
Company. The License Agreement provides for the payment by JMAR of a royalty of 2.5% of the net
sales of certain licensed products for a six year period, with the right to reduce the royalty to
1.25% after four years if we are no longer using the PointSource technology. The Licensed
Products consist of any scattered-radiation-based product used to detect or classify
microorganisms in water (including our BioSentry product) and any other product that is within the
scope of the licensed PointSource patents. As additional consideration for the License Agreement,
we also entered into a Securities Purchase Agreement providing for the issuance to PointSource of
520,000 shares of Common Stock (PointSource Shares) and Warrants (PointSource Warrants) to purchase
333,333 shares of Common Stock (PointSource Warrant Shares), with an exercise price of $1.38 per
share, and a term of 5 years. PointSource was also granted the right to purchase additional shares
in an amount equal to 1.66% of the shares sold in certain subsequent issuances by us on the same
terms as such issuance. PointSource subsequently assigned this additional purchase right to its
affiliates (PointSource Investors), together with 500,000 of the PointSource Shares and all of the
PointSource Warrants. This purchase right must be exercised within 20 days after the Company gives
notice to the PointSource Investors of the completion of a securities issuance. This purchase right
expires in July 2006. The PointSource Investors exercised this purchase right as it related to the
February 1, 2005 offering and purchased 53,548 shares of Common Stock and Warrants to purchase
20,081 shares of Common Stock with an exercise price of $1.73. LXT Alliance Agreement (BioSentry) During the second quarter of 2004, the Company entered into an alliance agreement with Gregory
Quist and David Drake, dba The LXT Group (LXT) to produce the BioSentry. 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 December 31,
2004, the Company had fulfilled this commitment. The alliance agreement also provided for execution
of a purchase agreement (Original 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. On February 21, 2005, JMAR and LXT executed a Technology Transfer and License Agreement
(License Agreement) that terminated and replaced the Original Purchase Agreement. The License
Agreement provides for the transfer to JMAR of certain trademarks and rights to certain designs and
data related to the BioSentry product, plus the grant of an exclusive, perpetual, worldwide license
by LXT to JMAR to use certain technology covered in a pending utility patent application filed by
LXT in January 2005 with the United States Patent & Trademark Office entitled Continuous On-Line
Real-Time Surveillance System. The scope of this license is limited to the use of light scattering
for detection of microorganism contamination and other particles in water. In consideration for the
transfer of the rights and license of the technology described above, JMAR agreed to pay LXT a
royalty equal to two percent (2%) of the gross revenue of any nature arising from the BioSentry
system used for the detection of microorganisms in water regardless of the technology employed,
commencing on the date JMAR receives the first dollar of BioSentry revenue (Revenue Start Date) and
continuing until the seventh anniversary thereof. The royalty payments are payable on a quarterly
basis within 45 days after the end of each quarter. The License Agreement also modified the
outstanding $125,000 loan to provide that it will no longer be secured by the LXT assets and to
provide that it shall be satisfied solely from royalty payments generated from revenues received
after the third anniversary of the Revenue Start Date and shall be repaid by payment of 50% of such
royalty payments until repaid in full (Amended Loan). The Amended Loan will accrue interest at the
prime rate starting on April 2, 2005 until satisfied or discharged. In connection with the
execution of the License Agreement, JMAR also entered into a Consulting Agreement for Technical and
Other Services for the provision of consulting services to JMAR by LXT (Consulting Agreement).
Pursuant to the Consulting Agreement, JMAR agrees to engage LXT to perform at least 1100 hours of
consulting services at the rate of $110 per hour until December 31, 2005, with the provision of and
payment for a minimum of 50 hours of agreed-upon services in any month. This consulting obligation supersedes and replaces the
prior agreement under the Original Purchase Agreement to enter into three year employment
agreements. 21




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##### Table of Contents



Net Operating Loss Carryforward At December 31, 2004, the Company had approximately $50 million of Federal net operating loss
carryforwards subject to certain annual limitations, which expire from 2005 through 2024. 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 and warrant valuation,
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 For each of the three years ended December 31, 2004, 2003 and 2002, in excess of 95% of the
Companys revenues were contract revenues, with the remainder mostly spare parts sales and service.
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 quarterly, 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.
Reimbursable or recoverable general and administrative (G&A) costs are charged to G&A expense as
incurred. Goodwill and Intangible Assets In accordance with FASB Statement 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. Management performed an interim evaluation of goodwill as of June 30, 2004 following
notification that no additional funding was included in the Governments fiscal year 2005 budget. A
further evaluation of goodwill was performed again as of December 31, 2004. The business units
currently identified are Vermont Operations/Research Division, Microelectronics Division and Sensor
Products Group. All of the Companys goodwill arose from the acquisition of SAL, Inc. (the
predecessor to the Vermont Operations) and is allocated to the Vermont Operations/Research Division business unit. The Research Division and
Vermont Operations are viewed as one business unit due to the interrelations of their businesses
(i.e., X-ray source related commercialization, including the XRM and XNP products, with the source
and technology development coming from the Research Division and the product design, manufacturing
engineering, integration, testing 22




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and manufacturing performed by the Vermont Operation, as well as
the zone plate optics development and manufacturing for the XRM and XNP performed by the Vermont
Operations). Additionally, the Vermont Operations will use its core capabilities to perform
manufacturing for other products of the Company, as well as performing contract manufacturing for
other companies products. The discounted cash flow analysis is based on a 7-year projection of revenue, operating
expenses, capital expenditures, and working capital requirements and a continuity value of 5 times
the 7th year cash flow. The discount rate used for the most recent analysis is 30%, taking into
account the riskiness of the new products. Sensitivity analysis is also performed to determine the
appropriateness of the assumptions used in the discounted cash flow analysis. As a majority of the
Companys expected revenues in the future are based on products that are currently under
development, the Company estimates the expected revenues based on its current knowledge of the
market and our expectations of successfully penetrating those markets. If our future cash flows
vary significantly from our assumptions we may record an impairment of goodwill. The market capitalization test is used as a complementary test to the discounted cash flow
analysis. The Company estimates its market capitalization based on the average stock price over the
preceding year and estimates the three business units relative contribution to the market value of
the Company based on shareholder inquiries, emphasis by the Company in discussions with
shareholders and others, and emphasis in formal shareholder communications (i.e., press releases). Capitalized patent costs are amortized over ten years, and other intangible assets are
amortized over not more than five years. Capitalized patent costs are reviewed quarterly for
utilization and recoverability. Beneficial Conversion Feature and Warrant Valuation In accordance with Financial Accounting Standards Board (FASB) Emerging Issues Task Force
Issue (EITF) No. 98-5 and FASB EITF No. 00-27, the Company records a beneficial conversion feature
(BCF) related to the issuance of convertible preferred stock and convertible debt that have
conversion features at fixed rates that are in the money when issued and records the fair value of
warrants issued with those instruments. The BCF for the convertible instruments is recognized and
measured by allocating a portion of the proceeds to warrants and as a reduction to the carrying
amount of the convertible instrument equal to the intrinsic value of the conversion features both
of which are credited to paid-in-capital. The Company calculates the fair value of warrants issued
with the convertible instruments using the Black Scholes valuation method, using the same
assumptions used for valuing employee options for purposes of FASB Statement No. 123, except that
the contractual life of the warrant is used. 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 from the date of issuance to the earlier of the maturity date of
the debt or the conversion dates using the effective yield method. 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. 23




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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. In December
2004, the FASB issued FASB Statement No. 123(R), Share-Based Payment, (SFAS No. 123(R)) which is
a revision of SFAS No. 123 and which supersedes APB Opinion No. 25. SFAS No. 123(R) requires all
share-based payments to employees, including grants of stock options, to be recognized in the
income statement based on their fair values. SFAS No. 123(R) must be adopted no later than January
1, 2006. 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 are
forward-looking statements, 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. These forward-looking statements
are based on certain assumptions and are subject to certain risks and uncertainties that could
cause actual future performance and results to differ materially from those stated or implied in
the forward-looking statements. In addition to the several risks and uncertainties described in this Managements Discussion
and Analysis of Financial Condition and Results of Operations, additional risks and uncertainties
include the following:  
    delays and unanticipated technological or engineering difficulties in the Companys new
product development efforts, which involve lengthy and capital intensive programs that are
subject to many unforeseen risks, delays, problems and costs and uncertainties as to the
markets demand for such new products;
    the risk that the performance validation tests of the
BioSentry Beta units are not successfully completed due to unforeseen
issues with the installation or operation of the units outside the
controlled environment of JMARs facility;
    the risk that competitors with greater resources enter the markets for the Companys new
products;
    the risk that the Company will not be able to convince
customers to substitute the BioSentry for existing products, such as
particle detection, filtering and other water decontamination
technologies;
    the risk that our portfolio of intellectual property does not contain all of the
intellectual property rights that may be required to develop, manufacture and commercialize
our new products and that we may be unable to license such technologies on reasonable
terms;
    the effect of government regulations and required approvals on the BioSentry and X-ray
products;
    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;
    the continued dilution to current shareholders resulting from the sale of additional
equity interests to finance the Companys product development and commercialization
efforts;
    unanticipated difficulties and costs in establishing the Companys Vermont operations as
the manufacturing center for the Companys new products; 24




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
    the lack of availability of critical components from third party suppliers, including
laser diodes, X-ray optics (including zone plates),
holographic optical elements and other optics 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, BioSentry
and other technologies and applications; and
    other risks detailed in the Companys Form 8-K, filed March 30, 2005, and in other
filings with the Securities and Exchange Commission. 
 Item 3.Quantitative and Qualitative Disclosures About Market Risk. The Company is required to provide quantitative and qualitative information about market risks
(interest rate risk, foreign currency risk, commodity price risk and other relevant market risks)
to the extent such risks are material to the Company. The Company has no investments in derivative
financial instruments nor in commodities. The Companys interest rate risk due to near-term changes
in market rates or prices is not material to the Companys earnings or cash flow. 
 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 March 31, 2005 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. There have been no changes in the Companys internal control over financial reporting during
the quarter ended March 31, 2005 that have materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting. The Company is not an accelerated filer and, therefore, the internal controls certification
and attestation requirements of Section 404 of the Sarbanes-Oxley Act were not applicable to the
Company for the fiscal year ended December 31, 2004. 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) On February 1, 2005, the Company entered into a Securities Purchase Agreement and
completed the sale of $4 million of the Companys Common Stock and Warrants to five
institutional investors (Investors). Pursuant to the Securities Purchase Agreement, the
Company issued a total 25




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of 3,225,807 shares of Common Stock and Warrants to purchase
1,209,679 shares of Common Stock to the Investors. The Warrants have an exercise
price of $1.73 per share and a term of five years. After expenses of the transaction
and the advisors fee, the Company received net proceeds of approximately $3,852,000.
The other material terms of these securities are described in the Notes to
Consolidated Financial Statements and in the Managements Discussion and Analysis
of Financial Condition and Results of Operations elsewhere in this Report. These issuances were
exempt under Section 4(2) of the Securities Act of 1933 and Regulation D thereunder. (a)(ii) Also, in February 2005, certain investors purchased a total of 53,548 shares of Common
Stock and Warrants to purchase 20,081 shares of Common Stock with an exercise price
of $1.73 per share for a total purchase price of $66,400. The other material terms
of these securities are described in the Notes to Consolidated Financial
Statements and in the Managements Discussion and Analysis of Financial Condition and Results of Operations elsewhere in this Report.
This issuance was exempt under Section 4(2) of the Securities Act of 1933 and Regulation
D thereunder. (a)(iii) On February 1, 2005, the Company entered into agreements with Laurus to amend the
Companys Series E, F, G and H Convertible Preferred Stock (Amendments). The
Amendments provide for the deferral of approximately $3.8 million in
monthly redemption payments, the grant of a right to the Company to
elect to pay the originally scheduled monthly redemption payments with shares
of the Companys Common Stock valued at a 15% discount to the then market price,
and the reduction in the conversion prices of the Series E-H Preferred Stock
(originally ranging from $2.85 to $3.47) to $2.00 per share. The other material terms of these
securities are described in the Notes to Consolidated Financial Statements and
in the Managements Discussion and Analysis of Financial Condition
and Results of Operations elsewhere in this Report. To the extent the
Amendments are viewed as the sale of new securities, this transaction was exempt
under Section 4(2) of the Securities Act of 1933. (a)(iv)In connection with entering into a License Agreement with PointSource
Technologies, LLC (PointSource) in January 2005, JMAR issued PointSource 520,000 shares of Common
Stock and Warrants to purchase 333,333 shares of Common Stock, with an exercise price of $1.38 per
share, and a term of 5 years. The other material terms of these securities are described in the
Notes to Consolidated Financial Statements and in the
Managements Discussion and Analysis of
Financial Condition and Results of Operations elsewhere in this Report. This transaction was
exempt under Section 4(2) of the Securities Act of 1933. 
 Item 6.Exhibits. Exhibit 10.1
    
    Technology Test and Contingent
Purchase Agreement for BioSentry, dated April 13, 2005, between JMAR
Technologies, Inc. and Kimpen, S.A. de C.V.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.
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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.May 13, 2005
    
    By:
    
    
    
    /s/   Ronald A. WalrodRonald A. Walrod, Chief Executive Officerand Authorized OfficerBy:
    
    
    
    /s/  Dennis E. ValentineDennis E. Valentine, Chief Accounting Officer
 27