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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                  FORM 10-K405

[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934

For the fiscal year ended                           December 31, 1996
                              --------------------------------------------------

                                       or

[  ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

Commission file number           1-10515
                              ------------------------


                              JMAR Industries, Inc.
--------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)


             Delaware                                   68-0131180
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  (State or other jurisdiction of           (I.R.S. Employer Identification No.)
   incorporation or organization)

3956 Sorrento Valley Blvd., San Diego, CA                  92121
------------------------------------------   -----------------------------------
  (Address of principal executive offices)               (Zip code)

Registrant's telephone number, including area code:       (619) 535-1706
                                                   -----------------------------


Securities registered pursuant to Section 12(b) of the Act:


       Title of each class             Name of each exchange on which registered
       -------------------             -----------------------------------------

 Unit (Common Stock and Warrant)                    Boston Stock Exchange
---------------------------------      -----------------------------------------


Securities registered pursuant to Section 12(g) of the Act:


                      Common Stock, $.01 par value; Warrant
--------------------------------------------------------------------------------


         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [  ]

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
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         The aggregate market value of the common stock held by non-affiliates
of the Registrant as of March 3, 1997 was approximately $43,064,208. The
aggregate market value was based on the closing price on March 3, 1997 for the
common stock as quoted on the NASDAQ National Market System.

         Number of shares outstanding of common stock:  Common Stock, $.01 Par 
Value - 16,860,269 shares as of March 3, 1997.




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                                     PART I

ITEM 1.  BUSINESS

GENERAL

         Founded in 1987, JMAR Industries, Inc. (the "Company" or "JMAR"),
headquartered in San Diego, California, develops and manufactures a wide range
of precision measurement and manufacturing systems based on the application of
advanced precision light sources, including lasers. The Company also employs
lasers to manufacture specialty semiconductors and is actively engaged in the
development of X-ray lithography, an enabling technology for the development of
future generations of high-performance semiconductors. JMAR operates through
three divisions located in Southern California:

         PACIFIC PRECISION LABORATORIES ("PPL"), the Company's equipment
manufacturing division is located in Chatsworth, California, northwest of Los
Angeles where JMAR's core product lines are produced. These currently include:
Test and Measurement Systems - non-contact systems to measure and inspect
microelectronics (primarily semiconductors and disk drives) parts for both
quality assurance and process control purposes; Motion Control and Positioning
Systems - to improve the precision of microelectronics manufacturing; and Laser
Processing Systems - which perform the highly precise welding, trimming and
cutting required by the microelectronics and medical implant industries.

         CALIFORNIA ASIC ("CAL ASIC"), the Company's newly established
quick-turn semiconductor design and fabrication operation located south of Los
Angeles in Irvine.

         JMAR TECHNOLOGY CO. ("JTC"), the Company's research and development
center in San Diego where JMAR technologists conceive the products of tomorrow
and refine them for commercial application. The Company conducts its work on
advanced X-ray and optical lithography, new medical products, micromachining,
and other leading-edge product technologies at this location.

BUSINESS SUMMARY

         JMAR's business involves the utilization of specialized forms of light
energy such as lasers or precision regulated light sources. Those business
operations fall into two categories: Current Products and Emerging Products.

CURRENT PRODUCTS

         CURRENT PRODUCTS are those which JMAR produces and sells today.
Manufactured by PPL, they include:

         TEST AND MEASUREMENT EQUIPMENT - MEASUREMENT, INSPECTION AND ALIGNMENT.
During 1996, JMAR's non-contact video and laser-based Test and Measurement
Equipment product line accounted for 50 percent of the Company's revenues.
JMAR's test and measurement systems are sold primarily to manufacturers of
semiconductors and computer disk drives. This line utilizes state-of-the-art
machine vision and laser position sensors integrated with programmable optics
and lighting control, precision X-Y-Z motion control and other computer
controlled functions. Vision, laser and other sensors are used to check changes
in variations in geometries. Proprietary algorithms are then written by PPL for
edge sensing, height sensing and point taking and fed into mathematical formulas
to determine straightness of lines, dimensional data, height measurements,
angles and radii of curvature of microscopic devices.


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         In late 1995, JMAR introduced its new compact Mirage tabletop,
non-contact, high-resolution video/laser measurement system to complement the
larger series 3000 and 4000 systems all of which are targeted towards the
microelectronics industry. The Mirage can be used for a variety of applications
including incoming and outgoing inspection, off-line process control for
equipment, process verification and many laboratory functions. The Company's
standard Series 3000 systems incorporate video-based measurement and offer
several different sizes of X-Y stages while the larger Series 4000 combines
video and laser height probes to provide high accuracy X-Y-Z measurements.

         LASER SYSTEMS. The Company manufactures laser processing systems,
precision laser hermetic sealing systems and laser machining and welding centers
which, collectively, contributed 17% of 1996 sales revenue.

         Laser Processing Systems. JMAR's laser processing systems utilize
state-of-the-art lasers for microelectronics manufacturing and repair. As
semiconductor assemblies such as Multi-Chip Modules ("MCM") approach the
complexity, densities and small feature sizes of semiconductor devices of the
early 1970's, there is a growing need for higher precision instruments to probe,
inspect and repair them. The Company's optical inspection stations are used to
locate open and short circuits while our Laser Processing Stations are designed
to meet today's demanding requirements for MCM substrate repair. Pulsed and
continuous wave laser sources covering the optical spectral range from infrared
to deep ultraviolet are used singly or in combination to create flexible, cost
effective systems for engineering evaluation or production.

         Current system models use either excimer lasers to repair MCM short
circuits by removing excess material or argon ion lasers to repair open circuits
by chemical vapor deposition("CVD"). The excimer tools are capable of delivering
a broad combination of power levels, material removal, spot sizes and energy
uniformity. Systems which incorporate JMAR's newly patented short pulse solid
state laser ("Britelight(TM)") technology are currently in the prototype
development phase and are expected to be available before the end of 1997.

         Precision Laser Hermetic Sealing Systems. JMAR's LSS-9000 high-powered
Nd:YAG laser hermetic sealing systems are used primarily by electronic and
medical equipment manufacturers for leak-tight sealing of medical implant and
electronic packages. These systems provide superior performance relative to
conventional electrical resistance welding methods for joining and sealing
low-resistance metals such as aluminum, titanium and copper alloys. The primary
users of laser-based hermetic sealing systems are manufacturers of aerospace
assemblies, electronic assemblies used in marine environments and manufacturers
of devices and assemblies designed to be implanted in the human body. The
Company has historically limited the market in which its precision laser welding
systems compete to the handling of objects that require manufacturing travel
distance of less than 3 feet in any direction, and which normally have a
relatively high value-added component.

         Laser Machining and Welding Centers. JMAR also produces Laser Machining
and Welding Centers for targeted marketplaces in the microelectronics industry.
These products include high accuracy small component welding systems which
utilize vision controlled alignment and sub-micron position repeatability. The
Company also produces processing stations for welding of microelectronic
feed-throughs and medical implantables and systems for welding critical computer
disk drive components. JMAR's precision micro-positioning and vision processing
technologies are incorporated into its Laser Machining and Welding Centers to
provide customers with single source, full turnkey manufacturing systems which
often include laser beam delivery systems, parts handling and identification
readers.

         POSITIONING AND MOTION CONTROL. During 1996, the Positioning and Motion
Control product line accounted for 22 percent of the Company's revenues. JMAR
manufactures a wide range of precision customized positioning stages and motion
control devices for the microelectronics industry, including a standard product
line of stages with full turnkey solution 


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capabilities. These stages which are the fundamental building blocks of many
microelectronic measurement and manufacturing systems, are often integrated into
custom systems to meet specific customer requirements. In addition, the Company
provides positioning components and systems for original equipment manufacturers
("OEM") as well as for its own test and measurement equipment and laser
processing products.

         CUSTOM PRODUCTS. In addition to its standard products, JMAR's PPL
division designs, engineers and manufactures customized systems based on its
motion control, measurement and/or laser system capabilities to meet specified
requirements of customers. Frequently, the design of a particular custom product
may lead to additional sales of that product to the customer.

         CONTRACT RESEARCH AND DEVELOPMENT. The Company performs profitable
research and development contract work at JTC for third party customers,
including the U.S. government and a large medical equipment company. The goals
of these efforts are to develop commercially significant products based on the
Company's proprietary laser and advanced optical technology. During 1996
contract R&D contributed 11% of JMAR's revenues.

EMERGING PRODUCTS

         JMAR's contract and company-funded R&D programs, collectively, have
created a broad world-class technology base that provides the foundation for an
array of important new commercial product lines and business areas which the
Company refers to as its "Emerging Products". JMAR's Emerging Products,
described in the following sections, include: Advanced microlithography for
semiconductor manufacturing, laser micromachining systems, the pocket-laser
Light Knife for blood sampling and small volume, quick-turn custom semiconductor
manufacturing.

         ADVANCED LITHOGRAPHY FOR SEMICONDUCTOR MANUFACTURING. Lithography is
the most critical process in the manufacture of semiconductors. It is a
photographic-like process which transfers circuit designs onto the chips thereby
determining the size of circuit features and the density of circuits on a chip.
A typical lithography system consists of an illumination source integrated into
an apparatus known as a "stepper" or an "aligner". The combined system is
installed in the semiconductor fabrication line.

         Semiconductors are the engines that drive the Technology Industry.
Whereas the economics of most industries are driven by consumption or
deterioration, the economics of the semiconductor industry are driven by
continuous innovation because semiconductors do not wear out. To continue to
grow, the semiconductor industry must develop ever more powerful computer chips
at a rapid pace. That requires continuing advances in the ability of the
Industry to produce ever-smaller circuit feature sizes which make it possible to
produce higher circuit densities. Advanced lithography systems, employing
shorter wavelength illumination sources, are required to make smaller feature
sizes. JMAR is one of the world's leading developers of compact high-intensity
short-wavelength lithography sources, including X-rays and novel deep
ultraviolet light sources.

         The total size of the lithography market is substantial. The
semiconductor industry purchases between 1,500 to 2,000 new lithography systems
per year at prices ranging from approximately $700,000 to $7 million. As the
circuit feature sizes get smaller the prices of the lithography systems increase
rapidly. In X-ray lithography, the illumination is provided by the X-ray source.
From 1989 to 1991, the Company designed, patented and developed an optical
pulse-compression technique and integrated it with its ACEL excimer laser to
produce X-rays in the 10-14 angstrom regime where a substantial amount of
lithography process development has already taken place, worldwide. In February
1991, the Company successfully tested a laboratory version of its excimer
laser-driven plasma X-ray source, thereby achieving a major milestone in its
program. Also, in subsequent experiments with a U.S. government laboratory, the
Company 


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demonstrated X-ray generation at 130 angstroms (commonly referred to as
the Extreme Ultraviolet or "EUV" regime) using a 50 nanosecond laser pulse
duration. Sources producing illumination in both the X-ray and EUV wavelength
regimes are expected to find applications in future generations of lithography.

         In January, 1994, after working on smaller government funded X-ray
lithography R&D contracts in prior years, JMAR received a $3.6-million contract,
with an option exercisable by the U.S. government for an additional $3.3
million, (of which $585,000 was funded in late 1995 and $2.2 million in 1996),
to develop JMAR's laser-plasma Picosecond X-ray Source ("PXS") for use in an
X-ray stepper system. Additional DARPA funding is anticipated in 1997 to develop
a prototype PXS for an entry-level x-ray lithography system with a throughput of
5 to 10 wafers per hour. The revenues from this contract constitute 9% of the
Company's 1996 sales. The contract was issued by the U.S. Army Research
Laboratory and is sponsored by the Defense Advanced Research Projects Agency
(DARPA) of the Department of Defense. By the end of 1997, the Company expects
that the cumulative amount of U.S. government contract funding for its X-ray
lithography point source development program will total approximately
$9,000,000.

         During the initial portion of its work under contract the Company made
considerable progress in the generation of high-repetition few picosecond (one
picosecond is equal to one trillionth of a second) excimer laser pulses which
proved advantageous for the generation of the required X-rays with a minimum of
contamination (one of the problems which has plagued attempts by other
competitors to produce practical X-ray sources has been the production of
unacceptable amounts of collateral debris that contaminates the lithography
process).

         During the latter part of 1994, JMAR initiated an Independent Research
and Development (IR&D) program based on the use of leading-edge diode-pumped
solid state laser technology to produce rapid rates of high energy
few-picosecond pulses for a range of potential applications, including X-ray
lithography. That program progressed so rapidly that the Company, with the
concurrence of its customer, phased in its new solid state PXS system as its
primary commercial X-ray source candidate and assigned its excimer laser-based
PXS to the study of more basic X-ray generation phenomenological studies.

         In July 1996 the U.S. government delivered to JMAR's San Diego facility
a government-owned X-ray Stepper which had formed the nucleus of a competitive
X-ray Lithography program at Bell Laboratories. That Stepper, developed over a
period of several years at an estimated cost of more than $25 million in both
government and other corporation funding, was intended, subject to the
availability of adequate government contract funding, to be integrated with
JMAR's solid state PXS to provide the foundation for an X-ray lithography
workstation to be made available to leading semiconductor makers for development
of next generation chip manufacturing processes. Since that delivery the Company
has been evaluating the alternatives available to it for expediting the
commercialization of its X-ray lithography sources. It is now also considering
other alternatives for the establishment of a point source X-ray lithography
demonstration work station, including recently developed commercial X-ray
steppers as well as the Bell Labs Stepper.

         MICROMACHINING SYSTEMS FOR INDUSTRIAL MANUFACTURERS. JMAR has
demonstrated an initial version of its Microlight 1000, a new micromachining
system that combines the Company's patented solid state picosecond
Britelight(TM) laser technology (developed by its JTC division) with one of its
proprietary material processing systems (developed at its PPL division) to
enable manufacturers to produce micro-sized products and perform a wide range of
micro-fabrication procedures.

         The Company has determined that the light beams produced by its
high-power picosecond lasers interact in very unique ways with certain materials
of interest to the microelectronics industry. The Company believes that these
unique interactions will enable makers of precision microcomponents to perform
new, previously unavailable manufacturing


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operations. JMAR has contracted for a detailed market research study and is
currently working with a number of micromanufacturers to evaluate the ability of
its Microlight system technology to improve the manufacture of current products
or to fabricate those that are impossible to make using conventional equipment.
During the first half of 1997 JMAR plans to upgrade the current Microlight 1000
system and customize it to meet the specification for the most promising markets
identified by the study.

         POCKET SIZE LASER BLOOD SAMPLERS. Another project currently under
development draws upon the Company's expertise in diode-pumped solid state
lasers to develop a battery-powered, pocket-size laser device for drawing blood
for diagnostic analysis for a large medical equipment supplier. Intended to
protect health care practitioners from the potential danger of disease
transmission related to the handling of needles and other sharp-edged sampling
devices, the Company's Light Knife(TM) laser devices are now in the prototype
stage with delivery of initial units scheduled for the second quarter of 1997.
The ultimate commercial success of this product will depend upon a number of
factors including technical performance, cost to produce and the ability of the
Company's customer to obtain FDA approval to market the products as well as the
ability of that customer to ultimately generate adequate sales volume.

         MANUFACTURE OF CUSTOMIZED SEMICONDUCTORS. In May, 1996, JMAR acquired
approximately 94 percent of the outstanding shares of Cal ASIC, a low-volume
manufacturer of application specific integrated circuits ("ASIC's"), an
important class of semiconductors. ASIC's are compact logic devices that can
process and integrate a series of functions within a single semiconductor chip.
Because of this, they are commonly used to enhance the performance of a broad
range of electronic devices, including computers, telephones, fax machines,
modems, televisions and medical products.

         Upon completion of the acquisition, JMAR immediately suspended Cal
ASIC's operations and commenced to upgrade its engineering capabilities and
re-equip its semiconductor fab facility to enhance the Company's competitive
capabilities in the market for specialty semiconductors. At yearend, Cal ASIC
had started accepting customer orders and was in the process of completing its
facility upgrade.

         In the conventional ASIC design cycle, chip layout and photomask
production are the most time consuming steps. The Cal ASIC process circumvents
this bottleneck by merging state-of-the-art design tools with a revolutionary
laser lithography production process that eliminates the need for expensive and
long lead-time photomasks. Coupled with a unique base wafer concept and onsite
processing, this direct linking of design and fabrication is expected to enable
Cal ASIC to perform low volume chip development and production in a fraction of
the time, and at a fraction of the cost of conventional ASIC production methods.

         The Company believes that Cal ASIC's unique ASIC development technology
will permit fast, affordable ASIC prototyping without complex processing or
unnecessary added steps. The core of the Cal ASIC approach is the direct write
laser system. The direct write laser system translates the ASIC design file into
an interconnect metalization pattern which is "written" directly onto
pre-processed, generic base wafers manufactured by high volume semiconductor
foundries. This direct write method eliminates the need for procuring hard
tooled photomasks, thereby cutting non-recurring engineering cost to an absolute
minimum.

         Since the direct write laser allows the custom circuit pattern to be
"written" on each chip, Cal ASIC is expected to be able to vary the design from
chip to chip, allowing multiple designs to be fabricated on a single wafer. This
should allow shorter prototype delivery times, provide added flexibility for Cal
ASIC customers and further improve the economics of the process.

MARKET

         The Company's technology base has applications in several market areas:


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LASER PROCESSING SYSTEMS

         The worldwide market for laser based material processing equipment is
generally viewed as being divided into two major application categories. The
first category is the cutting or joining of parts having large sections or
geometries that are over three feet in length (one meter). In general,
manufacturers of high power CO2 and Yag lasers dominate this market. The Company
chooses to compete in the second application category which involves the
manufacture of systems to handle objects that require a manufacturing travel
distance of less than 3 feet (one meter) in any direction, and which normally
have a high value added component. Such applications for the microelectronics
industry require small part handling systems, vision-aided alignment, use of
sub-micron positioning and laser pointing. Examples of applications of such
systems include spot welding of flexures used in the disk drive industry,
surgical tools and medical implants. Examples of small microelectronic parts
that require sub-micron positioning and alignment are the repair of multi-chip
modules (both open and short repair) and the repair or process of high density
interconnects.

         The Company believes that the laser based hermetic sealing market will
increase due to the growth in the market for implantable medical devices, as
well as the continued trend toward miniaturization and weight reduction in
avionics and space based telecommunications systems. The lower weight of
aluminum, titanium and similar lightweight metals has resulted in increased use
of such low electrical resistance metals which require laser based welding and
sealing systems. The Company expects to continue to participate in the continued
growth of this market.

         The selling cycle of the above products is relatively lengthy and runs
between three months and one year. This cycle corresponds with the customers'
capital budgets. The normal marketing process starts with a preliminary
feasibility study funded by either the Company or by the customer, followed by
process qualification, the obtaining of budgetary information, final contract
negotiations, manufacturing and sale.

TEST, MEASUREMENT AND POSITIONING SYSTEMS

         In this market, the Company concentrates on providing products for the
electronics industry, medical industry, aerospace and defense industries. The
mass storage industry (hard disk drives, tape backup systems and CD-ROM),
microelectronics, semiconductor and printed circuit board segments of such
industries constitute the targeted marketing focus of the Company. The Company
believes that the total sales in this market is in excess of $700 million.

         The specific market segments of the electronics manufacturing industry
targeted by the Company have common measurement problems which are ideally
solved through non-contact technologies, such as spectrophotometry, laser
interferometry and laser distant probes. By combining its expertise in
non-contact technologies with strong systems integration skills, JMAR believes
it is able to provide the solutions required by these targeted market segments.
The Company also believes that the continued trend toward small and more
intricate electronic devices will continue to increase the demand for
non-contact technologies, parts handling and full integration for a turnkey
solution in which it specializes.

SPECIALTY SEMICONDUCTORS

         The Cal ASIC specialty semiconductor business is focused on the
currently underserved low-volume and prototype gate array segments of the
rapidly expanding $17 billion worldwide market for ASIC's. Gate arrays, which
constitute about 40% of the entire ASIC market, are a series of customizable
semiconductor building blocks for a variety of critical digital computer
components.

         The low-volume gate array market, which the Company believes is
currently growing at a rate of approximately 15% per year, is estimated to be
more than $500 million. That demand 


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comes mainly from two sources. The first are the numerous chip developers or
product manufacturers who never need more than a few thousand chips of a given
design due to the limited number of products they build at any one time. This is
a very viable market due to the inability of large semiconductor factories,
which are set up for high-volume production, to handle short-run orders in a
cost-effective manner. Since they cannot do so, potential customers must look to
smaller fabricators like Cal ASIC.

         The second source of demand for gate arrays comes from manufacturers
that initially require only a limited number of gate array chips for prototypes
of new or upgraded products - such as computers, cellular telephones or fax
machines - but who may ultimately require very large quantities of them. These
customers need a fabricator with the ability to rapidly produce small quantities
of gate arrays that also can accommodate the many refinements to the product
that these manufacturers often make during the prototyping process. JMAR's
market research indicates that many of these customers would prefer to do
business with a fabricator that can eliminate the variations in performance that
frequently occur when a chip moves from a custom-designed prototype
manufacturing process to mass production.

MICROMACHINING

         The Company believes that a large potential market demand exists for
high performance systems which manufacture a broad range of ever-smaller
microdevices from materials which cannot be machined by currently available
fabrication tools. In December 1996 the Company contracted with an established
high technology market research firm to evaluate the current and expected
markets for its new laser-based micromachining systems including various
alternative configurations of its Microlight systems using JMAR's patented
Britelight lasers. The final results from this study are expected before the end
of March 1997.

ADVANCED LITHOGRAPHY

         Semiconductor device manufacturers purchase lithography tools from
established stepper suppliers. The principal suppliers of steppers for high
volume semiconductor production are Nikon, Canon, ASML, Silicon Valley Group
Lithography (SVGL) and Ultratech Systems.

         The Company understands that Canon and SVGL have X-ray lithography
stepper development and prototype programs underway. However, the primary
business focus of these companies is on the current multi-billion dollar optical
lithography stepper market. On the other hand, Suss Advanced Lithography (SAL),
a privately-owned venture headquartered in Vermont, was established several
years ago to focus on the X-ray lithography ("XRL") market. According to SAL, as
of the end of 1996 a total of 17 X-ray steppers have been sold, worldwide, for
X-ray lithography process development. SAL has informed JMAR that 16 of those
steppers were manufactured and sold by SAL. It is the Company's understanding
that those X-ray steppers were designed to interface with various synchrotron
X-ray source facilities currently being utilized, worldwide, for X-ray
lithography process development.

         JMAR believes that it is currently the world's leading developer of
"point source" X-ray lithography systems. The Company further believes that
point source XRL systems, once their X-ray outputs reach levels adequate for
commercially viable chip production rates, will provide the semiconductor
industry with a lower cost, much more compact and flexible alternative to
synchrotron facilities for X-ray lithography process development and production.

         One of the principal goals of the Company's 1997 XRL source development
program is the demonstration of the ability of the Company's patented
Britelight(TM) laser systems to generate commercially viable rates of X-rays
before the end of 1997.


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         The Company understands that the semiconductor industry is currently
transitioning its highest performance fab lines to the initial production of
circuitry, having feature sizes as small as 0.25 microns (i.e., the "critical
dimension"). The Company also understands that, with the exception of SAL, the
primary focus of the stepper manufacturers for the next few years will continue
to be on the marketing of optical lithography steppers.

         In approximately three years, full scale commercial production is
expected to transition to critical dimensions of 0.18 microns, followed by 0.13
microns about three years later. For each generation of chip technology,
full-scale commercial production operations are usually preceded by one to two
years of "pilot plant" operations by each semiconductor manufacturer. The pilot
operations, in turn, are preceded by a few years of laboratory process
development. According to Sematech, a non-profit semiconductor industry
technology evaluator, there are several candidate source technologies for the
0.18 micron generation and beyond. These include: extensions of current deep UV
excimer lasers, solid state lasers, synchrotron and point X-ray sources, extreme
UV, electron-beam and ion beams. Each of these technical approaches has its
proponents and detractors throughout the industry. Periodically, each cites the
strengths and weaknesses of the various techniques.

         The Company believes that, as a result of the X-ray lithography process
development conducted during the past decade, or more, by other organizations
using synchrotron X-ray sources, XRL is closer to commercial reality for the
0.18 micron generation and beyond than any of the other above-listed
alternatives with the possible exception of deep UV technology. The principal
roadblocks often cited by critics of XRL are: the size, cost and complexity,
radiation hazards and lack of availability of a commercially financed X-ray mask
supplier. The principal roadblocks often cited by critics for the extension of
deep UV to the 0.18 micron is the lack of demonstrated optical component
technology and the projected higher costs of the new stepper systems.

         The Company's XRL program is focused on the development of its PXS as a
commercially-viable X-ray source alternative to the synchrotron. Unlike
synchrotrons, the PXS source is not a hazardous radiation source. Furthermore,
commercial PXS source stepper systems for XRL are expected to cost less and be
of comparable, or smaller, size than projected DUV stepper systems for the 0.18
micron generation and beyond.

         Up to now, all X-ray masks have been fabricated in R&D or prototype
Mask Shops and, consequently, because of the low volumes have been quite
expensive. The Company believes that once XRL is adopted as a production
process, the projected mask production rates will justify the initial investment
required to establish commercial mask fabrication operations.

         The major technical milestone in the Company's PXS development program
is the continued scale-up in its Britelight laser technology to enable it to
generate commercially viable X-ray source outputs. JMAR's XRL contract with
DARPA, if fully funded on a timely basis, is intended to achieve that goal in
1997.

         For further information on the alternative technologies listed above,
the reader is advised to consult the publicly-available literature on this
subject.

         At the present time, the market for point source x-ray lithography
systems is believed to be limited to the sale of a few systems per year to
support the 0.18 micron process development programs of the major semiconductor
manufacturers and government supported research laboratories. That market is
expected to expand as the new 0.18 micron technology moves into the pilot plant
phase at leading manufacturers and then onto full scale production. Pursuant to
the Technology Roadmap prepared by the Semiconductor Industry Association (SIA),
the subsequent generation 0.13 micron technology will start moving into its
pilot phase as the 0.18 micron processes move into production. Many
semiconductor analysts believe that optical lithography has reached its feasible
resolution limit, and that commencing in the latter part of this 


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decade x-ray sources - both large facilitized synchrotrons and point sources
such as JMAR's PXS - will start making major inroads into this very large
market. The selling price for such point sources is expected to be approximately
two million dollars.

LIGHT KNIFE PRODUCTS

         JMAR has a light knife blood sampler product development agreement with
a large medical products manufacturer and currently expects its products to be
marketed by that customer. That customer has informed JMAR that the current
market for disposable blood collection devices is approximately $150 million per
year. JMAR's Light Knife blood collection system aims to compete for a
significant portion of that market. JMAR further believes that this market could
increase once healthcare practitioners become aware of the convenience and
safety advantages of Light Knife relative to current sharp edged products.

MANUFACTURING

         Due to the complex nature of the capital equipment that the Company
manufactures, JMAR purchases a substantial amount of components from outside
vendors for integration into its final systems. Purchased items include: major
electronics components, computers, optics, television cameras and motors, as
well as mechanical components designed by PPL, such as machine parts, sheet
metal enclosures, raw aluminum castings and other fabricated parts. The Company
has not encountered difficulties procuring these items and does not rely on
exclusive sole source suppliers. Should any of these parts become unavailable
from existing suppliers, the Company believes that alternative suppliers are
readily available for most of the critical components. However, the use of
alternative vendors and suppliers may have an adverse effect upon manufacturing
schedules and procedures and could affect delivery and increase costs. Assembly
and testing, as well as customer acceptance, are performed within the Company's
facilities.

         PPL has installed and integrated an internal information system which
includes a management information system that supports a fully integrated
material requirements planning system, which is run on PPL's internal local area
network. This system enables PPL to control its material requirements planning
and its production planning as well as all production.

         To accommodate customer expectations, and due to the complexity of the
equipment that the Company manufactures, delivery times after receipt of an
order typically range from 30 to 90 days for standard products and from 90 days
to one year for customized and special products.

         Cal ASIC has a manufacturing and sales agreement with an established
semiconductor manufacturer to share CMOS gate array design and manufacturing
resources. This agreement, along with its minifab facility and unique
proprietary technologies, will allow JMAR to provide electronic product
designers and prototypers with a unique, affordable, quick-response source of
small volumes of CMOS gate arrays that the Company believes will perform the
same as those produced by high-volume methods. It is JMAR's goal to utilize the
existing capabilities of its other divisions in advanced lithography, electronic
manufacturing process control and laser system motion control to assist Cal ASIC
to expand its production rates and the range of product offerings as market
opportunities arise.

RESEARCH AND DEVELOPMENT

         The Company has made substantial investments in the development of
specialized software used to control the operations of its hermetic laser
welding systems. A major effort in excimer laser delivery optics has produced a
leading edge excimer delete (e.g., ablative material removal) tool for
semiconductor system repair applications. In addition, the Company conducts a
continuing program to expand its accessories and the motion control capabilities
of its 


                                       11
<PAGE>   12


positioning equipment. Company-funded expenditures for research, development and
engineering were $1,304,119, $881,800, $995,520, $853,828 and $609,841 for the
years ended December 31, 1996, 1995, 1994, 1993 and 1992, respectively. Total
expenditures for RD&E including funding provided by third party contracts from
the U.S. government and other companies were $2,441,184, $2,118,550, $2,292,635,
$1,419,851 and $1,046,040 for the years ended December 31, 1996, 1995, 1994,
1993 and 1992, respectively.

         JMAR's JTC division is performing R&D contract work funded by the
Defense Advanced Research Projects Agency (DARPA) of the Department of Defense
and other customers. Its work for DARPA relates to: (1) X-ray lithography source
development, and 2) other advanced military system technology. During the past
five years, JTC has been awarded several contracts from the government relating
to the development of advanced manufacturing and military system prototypes
utilizing the Company's leading edge laser technology base. JMAR's PPL division
is responsible for the subsequent engineering and manufacturing of commercial
products based on these prototypes. Government funding of these dual use
technologies, however, is very vulnerable to changes in the political
atmosphere. For this reason, the Company is aggressively pursuing strategic
alliances with commercial microelectronics manufacturers as additional sources
of development funding.

         Some of the more significant research and development projects the
Company has worked on in 1996 include (i) continued development of a miniature
laser lancet system for needleless extraction of blood from the body; (ii)
continued development of an x-ray lithography source and novel advanced optical
lithography sources for advanced semiconductor manufacturing; (iii) continued
development of a fully integrated tabletop system used in the microelectronics
industry for non-contact high precision measurement of electronic component
dimensions; (iv) continued development of a disk inspection system for failure
analysis for the disk drive industry; (v) continued development of a standard
platform for laser machining and welding applications; and (vi) continued
development of the Microlight 1000 micromachining demonstration center.

DISTRIBUTION

         PPL sells its products on a worldwide basis. Prior to 1996, export
sales of PPL averaged in excess of 14% of total revenues, however, during 1996
export sales increased to in excess of 20% of total revenues. The increase in
export sales of PPL is due to the shipment to Europe of a large LSS 9000 welding
system (earlier LSS 9000 shipments to that same customer were installed in their
U.S. facilities).

         PPL utilizes a combination of direct regional sales personnel and sales
representatives to market its products in the United States. Foreign sales are
handled through independent distributors and representatives located in Europe
and the Pacific Rim countries. The distributors normally purchase equipment for
their own account and resell it to the end user in compliance with local law and
customs. They are appointed as exclusive distributors or representatives for
either a geographic area or a targeted product line and are responsible for
service support, training and installation to local customers.

COMPETITION

         PPL's principal competition for complete laser based hermetic sealing
systems in the United States is from companies which are principally laser
suppliers. The principal European competitor is based in Sweden. The competition
in laser based light industrial material processing systems is from both the
laser suppliers and smaller system integrators. There are a number of domestic
and international laser system manufacturers. Typically these manufacturers
either manufacture lasers or integrate systems (such as welding or marking) for
targeted marketplaces. The Company has positioned itself to be a high-end
integrator of leading edge, full turnkey laser processing systems incorporating
state-of-the-art Nd:YAG, argon-ion, or excimer 


                                       12
<PAGE>   13


lasers, as well as precision positioning, vision systems, remote parts handling
and full environmental control for the microelectronics industries. These
systems are primarily used for micromachining and short circuit and open circuit
repair of microelectronics components/systems.

         The Company believes that it is recognized as a leader in precision
motion control X-Y staging, components and systems. There are three major
domestic competitors. These competitors carry a much broader line, have much
larger distribution channels, and have a large stock of off-the-shelf inventory.
In addition, there are approximately five smaller competitors specializing in
narrower niches. Rather than compete in the generalized motion control and
positioning product marketplace, the Company has established itself as an
integrater of X-Y positioning and motion control systems and platforms for
several substantial OEM customers.

         The Company believes that it is recognized as a leader in test and
measurement systems utilizing vision and laser based depth probes. There are
approximately five domestic and three foreign competitors within JMAR's
marketplace. The majority of the competition supplies standard off-the-shelf
test and measurement systems for the microelectronics industry including the
mass storage industry. PPL's strengths against its competition is its ability to
integrate its positioning and motion control products with its standard test and
measurement systems to provide a turnkey system solution for manufacturing,
process control and quality control requirements. The Company's vision and laser
based systems are targeted for high-end applications requiring high resolution,
sub-micron edge detection, positioning and measurement accuracy. This enables
the Company to set itself apart from the mainline competition, which chooses to
compete in the lower resolution marketplace.

         In the area of specialty semiconductors, the Company's Cal ASIC
division faces competition from a small number of gate array producers using
traditional semiconductor manufacturing techniques with the attendant processing
times and costs. Currently customers needing only small volumes of custom
integrated circuits have few choices. They must either use expensive field
programmable gate arrays, or pay high costs to a major producer for limited
production, or develop their application using discrete components. Cal ASIC
provides another alternative through the use of a unique direct write
lithography approach that eliminates photomask generation and allows much faster
prototyping and cost effective small volume production. Additionally, Cal ASIC's
direct write lithography approach will permit multiple designs to be written on
the same wafer, giving customers the ability to do multiple iterations of their
designs at one time. While one competitor does use a laser in their prototype
offerings, it is an ablative approach which the Company believes produces parts
unsuitable for production or even long term evaluation.

         Four main competitors, all located in the western part of the U.S.,
have emerged in the niche that Cal ASIC serves. All four competitors offer
submicron technologies. Three possess full wafer foundries. Cal ASIC currently
uses 1.0 micron CMOS technology to serve its customers. Submicron geometry is a
perceived benefit for the competitors. However, the Company believes that the
great majority of customers in this market niche do not require submicron
technology, and that the Cal ASIC offering is suitable for a majority of the
market.

         The Company believes that it has established itself as the leading
developer of laser-plasma x-ray lithography point source systems. Although other
x-ray point source technologies are under development, the Company also believes
that upon achievement of commercially viable outputs laser-plasma point sources
of the type under development at JMAR may have the best long-term potential for
meeting commercial x-ray lithography requirements. The Company believes that its
diode pumped solid state laser-driven Pico Second X-ray Source (PXS), when
fitted with X-ray collimator devices developed by other DARPA contractors, will
be capable of generating x-rays of sufficient intensity to demonstrate
sub-quarter micron feature sizes at commercial production rates. JMAR's PXS
system has a significant competitive advantage over


                                       13
<PAGE>   14


alternative technologies because of certain unique technical features which the
Company believes will allow it to be readily integrated into semiconductor
fabrication processes.

PATENTS AND PROPRIETARY TECHNOLOGY

         JMAR owns a substantial body of proprietary software used in the
operation of its systems and believes that this software provides it with a
unique competitive advantage compared with its competitors in the laser systems
and measurement systems business.

         On July 18, 1995, JMAR was issued a patent for a "Low Cost, High
Brightness Solid State Laser" covering its solid state laser (i.e.,
"Britelight(TM)") and PXS technology.

         The Company holds numerous patents relating to lasers, their
applications and associated systems and one non-laser patent. The Company's
policy is to apply for a patent on each of its significant inventions not only
to preserve its proprietary rights but also to protect against reverse
engineering by others and to avoid being "locked out" of the use of its own
technology by other patents. The Company does not place its principal reliance
on patent protection; rather, it seeks to maintain a competitive advantage
through an aggressive R&D program, protection of non-patented proprietary data,
maintenance of its advanced laser-optics expertise, superior product performance
and active marketing of its products. However, it is recognized that lasers and
x-ray lithography are the subject of very substantial R&D activity by many very
competent companies and that other approaches may be developed and patented,
making the field very competitive.

         The Company's use of its laser technology is subject to the basic laser
patents owned and licensed by the Patlex Corporation ("Patlex"). Patlex holds
title to several of the basic laser and laser application patents originally
owned by Gordon Gould. Its position with respect to these patents has been
confirmed by the courts within recent years and most laser companies have signed
royalty agreements with Patlex since that time.

         The lasers sold by the Company are currently subject to royalties under
Patlex U.S. Patent No. 4,704,583. The Company holds all necessary licenses with
Patlex. The Company has been advised by two of its customers (the "Customers")
that Jerome Lemelson ("Lemelson"), a private inventor, has notified them that
its Customers may be infringing on one or more technology use and process
patents in the areas of Image Analysis and Manufacturing Apparatus which are
held by Lemelson and are incorporated into products manufactured by the Company
and other equipment manufacturers. These Customers have been asked by Lemelson
to license the use of the technology covered in these patents. The Company has
not determined whether or not it infringes on any of the Lemelson patents, nor
has any claim been made on the Company by any party.

DEVELOPMENT AND PRODUCTION STRATEGY FOR X-RAY LITHOGRAPHY

         JMAR's x-ray lithography source development strategy is based on
developing a modular x-ray source system which can be readily integrated with
any vertical-stage x-ray stepper, such as the current development-stage x-ray
steppers from Silicon Valley Group Lithography (SVGL), Canon, and Suss Advanced
Lithography (SAL). JMAR's commercialization plan for its x-ray source technology
is based on:

         1) JTC's understanding of the market requirements for advanced 
lithography; its x-ray source technology; and its experience with prototype
design and interface integration requirements of available steppers,

         2) PPL's  capability in  engineering,  product  manufacturing,  
assembly, test, and integration of precision manufacturing equipment for the
microelectronics industry, 


                                       14
<PAGE>   15


         3) The use of established commercialized system components (combined in
a unique, patented manner) which makes possible the use of existing U.S.
industrial infrastructure to supply and service the principal components of the
PXS systems.

CUSTOMERS

         For fiscal years 1996, 1995 and 1994, the United States Government
accounted for 9%, 15% and 18%, respectively, of total sales. Foreign sales
accounted for 21%, 15% and 31% of the Company's revenues in 1996, 1995 and 1994.
In 1996, three customers each accounted for in excess of 10% of JMAR's revenues:
IBM (29.5%), Medtronic (12.1%) and Therma-Wave (10.7%). In 1995, four customers
each accounted for in excess of 10% of JMAR's revenues: Therma-Wave (16.4%), IBM
(15.8%), Seagate Technology (11.3%) and Magnecomp (11.0%). In 1994, two
customers accounted for 13.3% and 10.2% of the Company's revenues. Both of them
were purchasers of Flying Height Testing products which were discontinued during
that year. 

EMPLOYEES

         Currently, the Company has approximately 110 full-time employees. The
Company is not subject to any collective bargaining agreements and believes that
it maintains excellent relations with its employees.

INDUSTRY SEGMENT INFORMATION

         Prior to the sale of Surgilase, Inc. in December, 1994, the Company
operated in two industry segments for financial reporting purposes as follows:
the Medical Equipment Group and the Manufacturing Equipment Group. Financial
information relating to the Company's export sales for the three years ended
December 31, 1996 is incorporated by reference from Note 14 of Notes to
Consolidated Financial Statements.

ITEM 2.  PROPERTIES

         The Company has a total of approximately 44,000 square feet of
laboratory, office, manufacturing and storage space under lease, including 9,280
square feet located in the Torrey Pines Business Park in the Sorrento Valley
region of San Diego, 15 miles north of San Diego International Airport. The
Sorrento Valley space is used for JTC's technology development activities,
including x-ray lithography and government contract businesses and for the
Company's corporate headquarters. That lease, which expires in August, 1997, is
at a current monthly rental of $5,661.

         In 1996 PPL added approximately 3,500 square feet of industrial space
to its existing 25,000 square feet. The new space was required to expand the
internal machining capability and to consolidate large inventory and storage
requirements. This enabled the main manufacturing plant of approximately 25,000
square feet to increase its production capability. In addition, the Company
maintains sales offices in San Jose, California and Dallas, Texas. In 1996 the
size of the Texas office was doubled to accommodate additional pieces of
demonstration equipment. PPL's manufacturing, office and storage facilities are
located 25 miles north of Los Angeles International Airport and have a monthly
rental of $16,173.

         Cal ASIC currently leases 6,596 square feet of manufacturing, office
and storage space south of Los Angeles in Irvine, California at a monthly rental
of $4,500 which expires in April, 1997. Cal ASIC is currently evaluating its
space needs for 1997 and beyond and is currently discussing a lease extension
with its landlord.

         The Company believes that its physical properties are adequate for its
current needs.


                                       15
<PAGE>   16


ITEM 3.  LEGAL PROCEEDING

         In July, 1995, a lawsuit was filed against Benchmark Industries, Inc.
("Benchmark") (a subsidiary of the Company which no longer has any assets or
operations) and Raytheon Company by two individuals in the U.S. District Court
for New Hampshire for an incident which occurred prior to the Company's
acquisition of Benchmark in September, 1992. The lawsuit alleged duty to warn,
strict product liability, negligence and ultrahazardous activity and loss of
consortium. The plaintiff sought general and compensatory damages in the amount
of $3,000,000. Benchmark has submitted the lawsuit to its insurance carrier and
believes that coverage is available for this lawsuit. Benchmark's insurance
company is currently paying the cost of defense of this lawsuit. It is the
Company's understanding that the plaintiff is no longer pursuing the lawsuit.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

                                      None.


                                     PART II

ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
         SHAREHOLDER MATTERS

         The Company's common stock and warrants are traded on the Nasdaq
National Market tier of the Nasdaq Stock Market ("NASDAQ-NMS") under the symbols
JMAR and JMARW, respectively. The 1996 and 1995 high and low transaction prices
for the common stock as reported by NASDAQ-NMS are set forth in the following
table.
<TABLE>
<CAPTION>

                             COMMON STOCK PRICE
                                                                          HIGH               LOW
                                                                      -------------     -------------
<S>                                                                       <C>              <C> 
1995
     First Quarter............................................                7/8             7/16
     Second Quarter...........................................            1 11/32              1/2
     Third Quarter............................................             2 3/32            1 1/4
     Fourth Quarter...........................................            1 11/16            15/16
1996
     First Quarter............................................            1 15/32            15/16
     Second Quarter...........................................             4 9/16            1 1/8
     Third Quarter............................................              3 5/8          1 15/16
     Fourth Quarter...........................................             3 1/16           2 3/32
</TABLE>

         There were  approximately  4,098  holders of JMAR's  common stock and 
638 holders of JMAR's publicly traded warrants as of February 25, 1997.

         The Company has never paid cash dividends on its Common Stock. The
Company currently intends to retain earnings for use in the operation and
expansion of its business and therefore does not anticipate paying any cash
dividends in the foreseeable future. The payment of dividends in the future by
the Company on its Common Stock will be dependent on its earnings and financial
condition and such other factors considered relevant by the Company's Board of
Directors.

         In October,  1996, the Company issued to an individual for facilitating
the closing of a transaction a warrant exercisable for 10,000 shares of Common
Stock at an exercise price of $2.25 per share. The warrant was issued to a
sophisticated investor in a transaction which was exempt under Section 4(2) of
the 1933 Act. 


                                       16
<PAGE>   17


ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

         The selected consolidated financial data that follows has been
extracted from the Company's Consolidated Financial Statements, which have been
audited by Arthur Andersen LLP, independent public accountants. It should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial Statements
and Notes thereto, which are included elsewhere in this report.

         The amounts for 1994, 1993 and 1992 have been adjusted from that
previously reported to reflect the operations of Surgilase as discontinued
operations as a result of its sale on December 9, 1994 but continue to contain
the results of several other business activities which the Company also
terminated in 1994. The financial data for 1993 includes the operations of PPL
since October, 1993. The financial data for 1992 includes the operations of
Benchmark since September, 1992. The balance sheet information includes the
accounts of Surgilase at December 31, 1993 and 1992, the accounts of Benchmark
at December 31, 1994, 1993 and 1992 and the accounts of PPL at December 31,
1996, 1995, 1994 and 1993. The financial data below includes the operations of
Texcel through December 31, 1993.


                                       17
<PAGE>   18
<TABLE>
<CAPTION>
                   CONSOLIDATED STATEMENTS OF OPERATIONS DATA
====================================================================================================================

                                               1992            1993             1994             1995           1996
                                               ----            ----             ----             ----           ----
<S>                                  <C>             <C>              <C>                 <C>            <C>        
Operating revenues..............     (1)$ 5,241,596  (1)$ 9,148,925   (1)$10,821,025      $12,210,490    $16,331,090
Revenues excluding terminated
  operations....................       (2)2,328,000    (2)3,620,925     (2)7,782,025       12,210,490     16,331,090
Gross profit....................          1,534,237       2,233,515        4,034,613        4,879,420      6,692,136
Operating expenses excluding
  restructuring charges.........          3,821,088       5,814,072        5,439,430        4,694,233      6,188,169
Restructuring charges...........                  -       5,112,000         (458,309)               -              -
Income (loss) from operations...         (2,286,851)    ( 8,692,557)        (946,508)         185,187        503,967
Interest expense................           (649,839)       (900,482)        (570,094)        (321,162)      (288,372)
Interest and other income
  (expense), net................            280,327         245,271          390,594          212,240        388,974
Loss on equity and other
  investments...................           (464,876)              -                -                -              -
Income (loss) from continuing
 operations before income taxes.      (3)(3,121,239)  (3)(9,347,768)   (3)(1,126,008)          76,265        604,569
Income tax benefit..............                  -               -                -                -        175,000
Income (loss) from continuing
 operations.....................         (3,121,239)     (9,347,768)      (1,126,008)          76,265        779,569
Discontinued operations:
    Loss from operations of
     discontinued operations....         (1,802,363)     (3,627,869)      (2,999,242)               -              -
    Loss on disposal of
    discontinued operations.....                  -               -         (540,404)               -              -
Net income (loss)...............         (4,923,602)    (12,975,637)      (4,665,654)          76,265        779,569
Per share data:
    Income (loss) per common share           
     from continuing operations.              (1.39)          (1.57)            (.11)             .01            .05
    Loss from discontinued
     operations.................              ( .80)          ( .61)            (.33)               -              -
    Net income (loss) per share.              (2.19)          (2.18)            (.44)             .01            .05
Fully diluted shares used in
  calculation of net income (loss) 
  per share.....................          2,252,008       5,958,413       10,596,661       14,133,258     16,906,584
</TABLE>
<TABLE>
<CAPTION>
====================================================================================================================
                                   CONSOLIDATED BALANCE SHEET DATA - DECEMBER 31,
====================================================================================================================
                                                1992            1993            1994            1995            1996
                                                ----            ----            ----            ----            ----

<S>                                       <C>             <C>             <C>             <C>             <C>       
Working capital ..................        $3,406,317      $1,423,318      $4,007,846      $4,655,087      $5,743,747

Total assets......................        13,890,391      19,137,447       9,107,968       9,248,995      15,395,518

Short-term debt...................         1,056,393       4,928,447         914,590       1,526,929       2,317,861

Long-term debt....................         4,489,419       3,189,664       2,165,417       1,536,273         667,310

Stockholders' equity..............         4,415,327       3,709,032       3,849,822       5,085,202       9,368,905
====================================================================================================================
</TABLE>
(1)      Excludes  revenue from the  discontinued  Surgilase  operations of 
         $5,277,406,  $6,776,603 and $4,771,775 for 1994,  1993 and 1992, 
         respectively.
(2)      Excludes revenue from Terminated Operations (See page 19).
(3)      Includes losses from Terminated Operations (See page 19).


                                       18
<PAGE>   19


ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

         The Company's product lines are subdivided into two categories: Current
Products and Emerging Products. Current Products are those produced and sold,
today, whereas the Emerging Product lines are developing businesses some of
which are supported by third party customer R&D contracts.

         JMAR had formerly operated in two industry segments which for financial
reporting purposes are as follows: the Medical Equipment and Accessories Group
and the Manufacturing Equipment Group. In recent years, the Medical Equipment
Group consisted primarily of the operations of Surgilase. This operation was
sold in December, 1994 and is accounted for as discontinued operations. As a
result, and in accordance with standard accounting practice, the revenues from
Surgilase operations are excluded from the revenues shown herein for 1994, and
the amounts for all other items related to Surgilase have been adjusted to
reflect the operations of Surgilase as a discontinued operation. Pursuant to its
restructuring in 1994, the Company also sold several other operations and assets
(the "Terminated Operations") which, in accordance with standard accounting
practice, have not been classified as "discontinued operations". Therefore, the
revenues and results of operations from the Terminated Operations are required
to be included in the Operating Revenues reported in the statements of
operations for prior years. To compare the revenues generated by those assets
which remained after the disposition of the Terminated Operations with the
revenues generated by such assets prior to the disposition of the Terminated
Operations, however, the second line of the Consolidated Statements of
Operations Data on the previous page reflects the revenues of the Company
excluding the revenues from the Terminated Operations.

RESULTS OF CONSOLIDATED OPERATIONS

         The Company achieved record performance in revenues, operating
profitability and net profitability during 1996. Operating income for 1996 and
1995 was $503,967 and $185,187, respectively, versus a loss of $946,508 for the
year ended December 31, 1994, while net income for those same periods was
$779,569 and $76,265, versus a loss of $4,665,654, respectively.

         On May 23, 1996, the Company acquired approximately 94 percent of the
outstanding common stock of California ASIC ("Cal ASIC"). The Company has
accounted for the acquisition as a purchase effective June 1, 1996. JMAR's
Operating and Net Incomes for 1996, $503,967 and $779,569, respectively, include
operating and net losses of $448,040 and $460,028, respectively, generated from
Cal ASIC's startup operations. Accordingly, JMAR's operating income and net
income, excluding the startup loss from Cal ASIC, were $952,007 and $1,239,597,
respectively, for the year ended December 31, 1996. The Company's outlook for
fiscal year 1997 is positive for operations that existed prior to the
acquisition of Cal ASIC. However, the Company expects a continuing adverse
impact on profits in the near term from Cal ASIC, including a non-cash charge of
approximately $195,000 per year for goodwill. It is management's belief that Cal
ASIC will become profitable before the end of 1997.

         At the end of 1993 the Company concluded that its efficiency of
operations and its future profitability would be significantly improved by
consolidating and restructuring its manufacturing equipment group operations.
Pursuant to the plan of consolidation, which was substantially completed prior
to the end of 1994, the Company sold two product lines and Texcel (with the
exception of certain Texcel laser material processing assets which were
transferred to PPL) and consolidated the remaining manufacturing equipment
operations into its PPL manufacturing division in Chatsworth, California. As
part of the consolidation plan, the Company also sold its Flying Height Testing
("FHT") equipment product line effective June 30, 1994.

         Revenues for each of the fiscal years ended December 31, 1996, 1995 and
1994 were $16,331,090, $12,210,490 and $10,821,025, respectively. Approximately
$3,039,000 in revenues 


                                       19
<PAGE>   20


from Terminated Operations were included in the revenues for 1994. Therefore,
the actual revenues for the fiscal years ended December 31, 1996, 1995 and 1994
from operations continued into 1995 were $16,331,090, $12,210,490 and
$7,782,025, respectively (approximately 45% compounded annual growth rate
compared with a compounded annual growth rate in excess of 62% for the five year
period 1992 to 1996). The increase in revenues for the year ended December 31,
1996 over the year ended December 31, 1995 is primarily attributable to the
overall increased volume of orders in 1996 for Disk Head Inspection Workstations
and new products, primarily the Mirage tabletop video measurement system.
Inventories have increased from $2,585,575 at December 31, 1995 to $3,855,312 at
December 31, 1996 primarily due to raw material and component purchases to
support the increased orders and higher levels of production planned for 1997.
The revenue increase for the year ended December 31, 1995 over the year ended
December 31, 1994 of approximately $4,428,000 was primarily attributable to
increased sales from Manufacturing Equipment products produced by the PPL
manufacturing division of approximately $4,510,000.

         Gross margins for the fiscal years ended December 31, 1996, 1995 and
1994 were 41%, 40% and 37.3%, respectively. The increase in gross profit margins
for the fiscal year ended December 31, 1996 versus the fiscal year ended
December 31, 1995 is primarily due to greater efficiencies in the manufacturing
process resulting from higher sales and production volume and the elimination of
a low margin product at PPL. Although the Company's margins have improved in
1996 as compared to 1995, it continues to experience competitive pressures on
certain products which may impact gross margins in the future. The lower gross
profit margins for the fiscal year ended December 31, 1994 versus the fiscal
year ended December 31, 1995 is primarily due to lower margin product lines of
Benchmark Industries, formerly a JMAR subsidiary which was eliminated as part of
the 1994 restructuring, and the re-location of the laser material processing
assets from the East Coast of the U.S. to Southern California. The Company took
action in 1994 to eliminate these lower margin products. The increased gross
margins for 1995 were partially offset by lower margins at PPL in 1995 versus
1994 due to increased outside vendor component purchases.

         Selling, general and administrative ("SG&A") expenses for the fiscal
years ended December 31, 1996, 1995 and 1994, were $4,884,050, $3,812,433 and
$4,443,910, respectively. The increase in SG&A expenses in 1996 is due to (i)
SG&A expenses of $448,040 related to Cal ASIC in 1996 compared to none in 1995;
(ii) increased amortization with respect to the larger quantity of demonstration
equipment, primarily related to the Mirage, required to support expanded
marketing efforts; (iii) higher customer service costs that resulted from adding
to the customer service staff to support increased sales volume experienced in
1996; and (iv) higher payroll costs. The decrease in SG&A expenses in 1995 as
compared to 1994 was due to lower expenses resulting from restructuring and
consolidation of the manufacturing equipment group at PPL in Southern California
and other cost reductions.

         The Company's research, development and engineering program (RD&E)
consists of two types: Customer-Funded RD&E (U.S. government and other
companies) and Company-Funded RD&E. Both types of RD&E are expensed when
incurred. Customer-Funded RD&E costs incurred, included in "Contract Costs of
Sales" expenses totaled $1,137,065, $1,236,750 and $1,297,115 for the fiscal
years ended December 31, 1996, 1995 and 1994, respectively. The decrease in
Customer-Funded RD&E for 1996 is primarily due to the delay in receipt of
additional contract funding from the U.S. government. Company-Funded RD&E costs
are shown in "Operating Expenses" and totaled $1,304,119, $881,800 and $995,520,
respectively. Hence, total RD&E expenses for those three years were $2,441,184,
$2,118,550 and $2,292,635, respectively.

         Interest expense for the fiscal years ended December 31, 1996, 1995 and
1994, was $288,372, $321,162 and $570,094, respectively. The decrease in
interest expense in 1996 versus 1995 is due to the conversion of $1,000,000 of
convertible notes into JMAR common stock in October 1996. The decrease in
interest expense in 1995 versus 1994 is due to the payoff or conversion of
approximately $2,500,000 of convertible notes in February 1994, the payoff or
conversion of approximately $2,401,000 of Benchmark debt in 1994 and the 


                                       20
<PAGE>   21


conversion or payoff of $700,000 of convertible notes in 1995. Included in
interest expense for fiscal year 1994 is amortization of certain Common Stock
warrant premiums totaling $7,295, and loan fees totaling $30,780, $51,525 and
$75,382, for the fiscal years 1996, 1995 and 1994, respectively.

         Interest and other income (expense) for 1996 includes a gain of
approximately $405,700 related to the settlement with Atlantic American Holding
Company Limited ("Atlantic") and early redemption of the preferred stock of
Atlantic that the Company held and includes a non-recurring charge of $80,000
recorded in the first quarter relating to an investment disposed of in a prior
year. Interest and other income (expense) for 1994 includes discounts obtained
by the Company against certain payables primarily related to Benchmark, a gain
on the sale of the FHT product line of PPL and a gain on the sale of stock in
another company and offset in part by a loss on the sale of assets of Benchmark.

         During 1994 the Company decided not to sell the Metrology line of PPL.
Accordingly, the previously established restructuring reserves for that
potential sale were reversed in 1994. This reversal was offset by additional
restructuring costs associated with the disposition and consolidation of certain
assets of Benchmark.

         During 1994, JMAR sold substantially all of the assets of Surgilase on
an installment sale basis for a price of approximately $6,700,000, the final
payment of which was received by the Company in June 1996. Discontinued
operations reflect a loss of $2,999,242 for the year ended December 31, 1994 and
a loss on disposal of discontinued operations of $540,404 in 1994.

         Included in the Statement of Operations  for the Company in 1996 is a 
tax benefit of $175,000 related to the utilization by the Company of a portion
of its net operating loss carryforward.

CONSOLIDATED LIQUIDITY AND FINANCIAL CONDITION

         Working capital as of December 31, 1996 was $5,743,747 compared to
$4,655,087 at December 31, 1995.

         Cash and cash equivalents at December 31, 1996 and December 31, 1995
were $2,629,286 and $1,837,647, respectively. The increase (decrease) in cash
and cash equivalents for the fiscal years ended December 31, 1996, 1995 and 1994
was $791,639, $(107,731) and $1,387,358, respectively. Cash from net income plus
non-cash operating items improved from a provision of cash of $663,071 for the
year ended December 31, 1995 to a provision of cash of $1,447,741 for the year
ended December 31, 1996. The increase in cash for 1996 resulted from cash
provided by financing activities of $1,429,441 (net proceeds from the exercise
of warrants, borrowings from notes payable, and net proceeds from issuances of
common stock, less net payments of short-term debt) offset in part by cash used
in operations of $413,687 and cash used in investing activities of $224,115
(primarily capital expenditures, increase in other receivables, and acquisition
costs, less cash received from the collection of notes receivable, primarily
related to the sale of Surgilase). The cash used in operations was primarily
used to finance accounts receivable and inventory purchases offset in part by an
increase in accounts payable and accrued liabilities. Accounts receivable
increased primarily due to an increase in revenues for the twelve months ended
December 31, 1996. Accounts payable and accrued liabilities increased primarily
due to (i) an increase in inventory purchases to support planned production
increases; (ii) an increase in deposits and progress payments obtained in
connection with customer orders; and (iii) accounts payable and accruals of Cal
ASIC.

         The decrease in cash for 1995 resulted from cash used in operations of
$1,625,119 (primarily to finance inventory and accounts receivable and to
paydown accounts payable and accrued liabilities) offset in part by cash
provided by investment activities of $1,076,835 (primarily cash received from
the note receivable related to the sale of Surgilase less capital 


                                       21
<PAGE>   22


expenditures) and cash provided by financing activities of $440,553 (primarily
net borrowings under short-term debt agreements less payments of notes payable).
The increase in cash for 1994 resulted from cash provided by investing
activities of $4,278,288 (primarily consisting of proceeds from the sale of
assets and Surgilase and payments received on notes receivable offset by capital
expenditures) and finance activities of $174,404 (primarily consisting of
proceeds from the issuance of common stock offset by payments of notes payable,
including convertible notes of $2,350,000) offset by cash used in operations of
$3,065,334.

         JMAR operations will continue to require the use of working capital.
The working capital of PPL is generally funded through its working capital line
(the "Line") with a bank (the "Bank") plus customer advanced payments made at
the time of order placements. The operations of JTC are currently funded through
third party contracts. During 1995 and most of the first quarter of 1996,
advances pursuant to the Line were based on 80 percent of eligible accounts
receivable and 25 percent of eligible inventories (up to $1,000,000). The Bank
increased the Line from $1,500,000 in the second quarter of 1995 to $3,000,000
in March, 1996, allowed certain foreign receivables (up to $250,000) to be
eligible receivables and increased the percent of eligible inventories to 35
percent. As of December 31, 1996, PPL's capital availability pursuant to the
Line was approximately $2,774,000 of which approximately $1,444,000 was
borrowed. The Line contains several covenants relating to, among other matters,
the maintenance of certain minimum income levels and financial ratios, which if
not met could impact the availability of advances pursuant to the Line. In
addition, during the third quarter, the Bank loaned the Company $500,000 to be
used for equipment purchases by PPL. Concurrent with the closing of the
acquisition (the "Acquisition") of Cal ASIC, the Company loaned $400,000 to Cal
ASIC (in addition to $100,000 previously loaned) and agreed to loan an
additional $1,000,000 over an eighteen month period, of which $500,000 was
loaned in the quarter ended September 30, 1996, and to be used by Cal ASIC for
equipment purchases and working capital purposes. In addition, the Company
agreed to loan the two majority shareholders of Cal ASIC up to $250,000 secured
by the JMAR stock they received in the Acquisition. During September, 1996, the
Company entered into a $950,000 lease financing agreement with Leasing
Technologies International, Inc., the proceeds of which will be used to finance
Cal ASIC equipment and software financing requirements. Management believes that
the Company has existing resources to adequately fund operations and working
capital requirements as well as the Cal ASIC obligations for the next twelve
months based on the current level of operations and business conditions.

         At December 31, 1996, the Company had in excess of $26 million of
Federal net operating loss carryforwards, subject to certain annual limitations.
To the extent the Company has taxable income in the future, these carryforwards
will be used by the Company to reduce its cash outlay for taxes.

FACTORS THAT MAY AFFECT FUTURE RESULTS

         Certain statements contained in this Form 10-K are forward looking
statements that involve a number of risks and uncertainties. In addition to the
factors discussed below, among the other factors that could cause actual results
to differ materially are the following: Concentration of sales to markets and
customers (see "Customers"), delays or cancellations in orders, fluctuations in
margins, timing of specific orders, customer reorganizations, demand
fluctuations, timely development, introduction and acceptance of new products,
technical obsolescence of existing products, technical problems in the
development or modification of current products, the impact of competitive
products and pricing, shifts in demand for the Company's products, the degree of
success of technology transfer (e.g., advanced lithography sources, laser blood
sampler, micromachining, etc.) to commercial products, availability of working
capital to support growth, continued government funding of advanced lithography,
successful integration of acquisitions, and other competitive factors.

         JMAR's future operating results are also dependent on its ability to
develop, manufacture and market, in a timely manner, innovative products that
meet customers' needs and the 


                                       22
<PAGE>   23


continued growth of the semiconductor, computer disk drive and medical equipment
industries. Inherent in this process are a number of risks that the Company must
successfully manage in order to achieve favorable operating results. The process
of developing new high technology products is complex and uncertain and requires
innovations that anticipate customer needs and technological trends. After the
products are developed, the Company must quickly manufacture them in sufficient
volumes at acceptable costs to meet demand and establish the necessary sales and
marketing capabilities to assure adequate and timely sales volume.

         In addition, portions of the Company's manufacturing operations are
sometimes dependent on the ability of a targeted base of suppliers to supply
core technology, sub-assemblies and common manufactured parts in time to meet
critical distribution and manufacturing schedules. From time-to-time the Company
could experience constrained supply of certain component parts due to a variety
of reasons, including strong demand in those product lines as well as strong
demand in the industry. Such constraints could adversely affect JMAR's operating
results until alternate sourcing is developed.

         As is the case for a large number of California-based companies, a
significant portion of the Company's operations are located near major
earthquake faults. The ultimate impact on the Company, significant suppliers and
the general infrastructure is unknown, but operating results could be materially
affected in the event of a major earthquake. The Company is predominantly
self-insured for losses and interruptions caused by earthquakes.

         The operations of the Company involve the use of substances regulated
under various federal, state and international laws governing the environment.
It is the Company's policy to apply strict standards for environmental
protection even if not subject to regulations imposed by local governments. The
liability for environmental remediation and related costs is accrued when it is
considered probable and the costs can be estimated. Environmental costs are
presently not material to JMAR's operations or financial position.

         Although JMAR believes that it has the necessary product offerings and
resources for continuing success, future revenue and margin trends cannot be
reliably predicted and may cause the Company to adjust its operations. Factors
external to the Company can result in volatility of the Company's common stock
price. Because of the foregoing factors, recent trends should not be considered
reliable indicators of future stock prices or financial results.

         During May, 1996, the Company acquired California ASIC a quick turn,
but as yet unprofitable, manufacturer of a special category of semiconductor
chips. The Company believes that Cal ASIC fits well with the Company's current
business activities and believes that the acquisition will improve the Company's
profitability and sales volume at some point in 1997. The initial expense of
integrating Cal ASIC into the Company and expanding its sales volume to
profitable levels has produced losses at Cal ASIC and may continue to produce
losses in the near term. Morever, despite plans for additional investment, there
are no guarantees that the operations of Cal ASIC will ever achieve
profitability. JMAR has performed what it believes is extensive due diligence on
the markets, the technologies and the management of Cal ASIC using both its
internal resources as well as several competent, independent outside consultancy
groups. On the basis of the information obtained, the Company is optimistic
regarding the potential future contribution of Cal ASIC to JMAR. However, there
are many possible factors which could negatively impact the achievement of these
expected future benefits, including: failure of the quick-turn gate array market
to materialize as rapidly as forecast, emergence of new competitors, possible
patent infringement claims, inability to attract and retain the additional
qualified employees required to manufacture and sell the Cal ASIC products and
services, failure of the manufacturing facilities to produce adequate quantities
and quality of products within the required time frame at profitable cost
levels, deterioration of the relationship between Cal ASIC and its base wafer
suppliers, litigation from prior creditors or shareholders of Cal ASIC, the
ability of the Company to raise the funds necessary to adequately finance the
working capital needs and equipment purchase needs of Cal ASIC as well as many
of the risk factors set forth above.


                                       23
<PAGE>   24


         The ultimate commercial success of the Company's pocket size laser
blood samplers will depend on a number of factors including technical
performance, cost to produce and the ability of the Company's customer to obtain
FDA approval to market the products and the ability of that customer to
ultimately generate adequate sales volume.

         The Company has not yet achieved commercially viable outputs in its
X-ray lithography program. In order to prove that its technology works and to
produce a completed product, the Company must complete the development and
integration of these highly technical and complicated systems into a
fully-integrated prototype. With any new technology, there is a risk that the
market may not appreciate the benefits of the product. In addition, the
Company's X-ray lithography system will compete against other developing
technologies. Development by others of new or improved products, processes or
technologies may make the Company's proposed product obsolete or less
competitive. Also, the development of sophisticated laser products is a lengthy
and capital intensive process and is subject to unforeseen risks, delays,
problems and costs.

         Although JMAR has demonstrated an initial version of its Microlight
1000, it has not yet sold the proposed product. Along with some of the risks
discussed in the preceding paragraph, the size of the potential market for the
product is not yet known. In addition, the Company has not proven that its
proposed product will improve the manufacturing of customer's products or
fabricate those that are currently impossible to make using conventional
equipment.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The financial statements prepared in accordance with Regulation S-X are
set forth beginning on page 27 hereof.



                                       24
<PAGE>   25


INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


<TABLE>
<S>                                                                                             <C>
Report of Independent Public Accountants.........................................................26

Consolidated Balance Sheets as of December 31, 1996 and 1995.....................................27

Consolidated Statements of Operations for the Years Ended December 31, 1996,
1995 and 1994....................................................................................28

Consolidated Statements of Stockholders' Equity for the Years Ended December 31,
1996, 1995 and 1994..............................................................................29

Consolidated Statements of Cash Flows for the Years Ended December 31, 1996,
1995 and 1994....................................................................................30

Notes to Consolidated Financial Statements.......................................................31
</TABLE>


                                       25
<PAGE>   26

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS




To JMAR Industries, Inc.:

         We have  audited  the  accompanying  consolidated  balance  sheets of 
JMAR Industries, Inc. (a Delaware corporation) and subsidiaries as of December
31, 1996 and 1995, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. These consolidated financial statements and the
schedule referred to below are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and schedule based on our audits.

         We conducted our audits in accordance with generally  accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, the financial  statements referred to above present 
fairly, in all material respects, the financial position of JMAR Industries,
Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.

         Our  audits  were made for the  purpose of forming an  opinion  on the 
basic consolidated financial statements taken as a whole. The schedule listed in
Item 14 is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic consolidated financial
statements. This schedule has been subjected to the auditing procedures applied
in the audits of the basic consolidated financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic consolidated financial statements
taken as a whole.



                                                   /s/ Arthur Andersen LLP
                                                   -----------------------
                                                   ARTHUR ANDERSEN LLP

San Diego, California
February 24, 1997


                                       26
<PAGE>   27


                              JMAR INDUSTRIES, INC.
                           CONSOLIDATED BALANCE SHEETS
                  AS OF DECEMBER 31, 1996 AND DECEMBER 31, 1995

<TABLE>
<CAPTION>
==================================================================================================================================

                                         ASSETS                                                              December 31,
                                         ------                                                              ------------
                                                                                                      1996                 1995
                                                                                                      ----                 ----
<S>                                  <C>                                                            <C>                 <C>       
Current Assets:
     Cash and cash equivalents (Note 2) ........................................                    $2,629,286          $1,837,647
     Accounts receivable, net (Note 5)..........................................                     2,994,762           1,742,484
     Notes and other receivable (Notes 11 and 13 )..............................                       902,005             979,165
     Inventories (Notes 2 and 4)................................................                     3,855,312           2,585,575
     Prepaid expenses and other ................................................                       721,685             137,736
                                                                                                   -----------          ----------
          Total current assets..................................................                    11,103,050           7,282,607
Notes receivable (Note 13 ).....................................................                        54,667             129,502
Receivable from officers........................................................                        73,824              69,524
Property and equipment, net (Notes 2 and 6).....................................                     2,704,460             571,622
Equity securities, at cost (Note 11) ...........................................                             -             621,000
Other assets, net  (Note 2) ....................................................                       347,627             290,208
Goodwill, net  (Notes 2 and 3)..................................................                     1,111,890             284,532
                                                                                                   -----------          ----------

         TOTAL ASSETS...........................................................                   $15,395,518          $9,248,995
                                                                                                   ===========          ==========

                          LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
     Accounts payable...........................................................                     $ 914,272         $   455,715
     Accrued liabilities........................................................                       535,885             215,768
     Accrued payroll and related costs..........................................                       849,072             423,845
     Customer deposits .........................................................                       742,213               5,263
     Convertible notes payable (Notes 8 and 11) ................................                       589,631                   -
     Notes payable and capital lease obligations (Notes 7 and 8)................                     1,728,230           1,526,929
                                                                                                   -----------          ----------
          Total current liabilities.............................................                     5,359,303           2,627,520
                                                                                                   -----------          ----------
Convertible notes payable (Notes 8 and 11)......................................                             -           1,536,273
                                                                                                   -----------          ----------
Notes payable and capital lease obligations, net of current portion (Notes 7 and 8)                    667,310                   -
                                                                                                   -----------          ----------
Commitments and contingencies (Notes 3, 7 and 9)
Stockholders' equity (Notes 3, 8, 9, 11 and 12):
     Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued and
         outstanding as of December 31, 1996 and December 31, 1995..............                             -                   -
     Common stock, $.01 par value; 40,000,000 shares authorized;
       Issued and outstanding 16,760,269 shares as of December 31, 1996 and 14,228,585
       shares as of December 31, 1995..........................................                        167,603             142,286
     Additional paid-in capital.................................................                    35,274,959          31,796,142
     Accumulated deficit........................................................                  (26,073,657)        (26,853,226)
                                                                                                   -----------          ----------
          Total stockholders' equity............................................                     9,368,905           5,085,202
                                                                                                   -----------          ----------

         TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.............................                   $15,395,518          $9,248,995
                                                                                                   ===========          ==========

==================================================================================================================================
</TABLE>
The accompanying notes to consolidated financial statements are an integral
part of these consolidated balance sheets.

                                       27
<PAGE>   28
                              JMAR INDUSTRIES, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994

<TABLE>
<CAPTION>
=======================================================================================================================

                                                                                      Year ended December 31,
                                                                                      -----------------------


                                                                               1996            1995            1994
                                                                               ----            ----            ----
<S>                                                                        <C>             <C>             <C>         
Product sales ..........................................................   $ 14,585,585    $ 10,351,949    $  8,501,017
Contract sales .........................................................      1,745,505       1,858,541       2,320,008
                                                                           ------------    ------------    ------------
          Total revenues (Note 14) .....................................     16,331,090      12,210,490      10,821,025
Product costs of sales .................................................      8,501,889       6,094,320       5,311,386
Contract costs of sales ................................................      1,137,065       1,236,750       1,475,026
                                                                           ------------    ------------    ------------
          Gross profit .................................................      6,692,136       4,879,420       4,034,613
                                                                           ------------    ------------    ------------
Operating Expenses:
     Selling, general and administrative ...............................      4,884,050       3,812,433       4,443,910
     Research, development and engineering .............................      1,304,119         881,800         995,520
     Restructuring charges (Note 13) ...................................           --              --          (458,309)
                                                                           ------------    ------------    ------------
          Total operating expenses .....................................      6,188,169       4,694,233       4,981,121
                                                                           ------------    ------------    ------------
Income (loss) from operations ..........................................        503,967         185,187        (946,508)
Interest and other income (expense), net ...............................        388,974         212,240         390,594
Interest expense .......................................................       (288,372)       (321,162)       (570,094)
                                                                           ------------    ------------    ------------
Income (loss) from continuing operations before income taxes ...........        604,569          76,265      (1,126,008)
Income tax benefit (Note 10) ...........................................        175,000            --              --
                                                                           ------------    ------------    ------------
Income (loss) from continuing operations ...............................        779,569          76,265      (1,126,008)
Discontinued Operations (Note 13):
     Loss from operations of  discontinued operations ..................           --              --        (2,999,242)
     Loss on disposal of discontinued operations .......................           --              --          (540,404)
                                                                           ------------    ------------    ------------
Net income (loss) ......................................................   $    779,569    $     76,265    $ (4,665,654)
                                                                           ============    ============    ============
Net income (loss) per common share and common equivalent share (Note 2):
     Primary and fully diluted:
     Income (loss) per common share from continuing operations .........   $        .05    $        .01    $       (.11)

     Loss per common share from discontinued operations................            --              --              (.33)
                                                                           ------------    ------------    ------------
Net (income) loss per common share .....................................   $        .05    $        .01    $       (.44)
                                                                           ============    ============    ============

Weighted average common and common equivalent shares outstanding:
     Primary ...........................................................     16,755,753      14,133,258      10,596,661
                                                                           ============    ============    ============
    Fully diluted ......................................................     16,906,584      14,133,258      10,596,661
                                                                           ============    ============    ============
=======================================================================================================================
</TABLE>

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



                                       28
<PAGE>   29
                              JMAR INDUSTRIES, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994


<TABLE>
<CAPTION>
                                                                                           Additional                          Total
                                                Common Stock            Preferred Stock     Paid-in       Accumulated  Stockholders'
                                              Shares       Amount      Shares    Amount     Capital         Deficit           Equity
                                          ------------   ----------   --------  --------  ------------   ------------   -----------
<S>                                       <C>            <C>          <C>       <C>       <C>            <C>            <C>
Balance, December 31, 1993.............     7,506,123   $   75,062       --    $   --    $ 25,897,807   $(22,263,837)  $ 3,709,032
Debt converted to equity (Note 11).....        58,160          581       --        --         112,375           --         112,956
Issuance of common stock and
   warrants (Note 11)..................     4,625,000       46,250       --        --       4,704,230           --       4,750,480
Stock issued upon litigation      
   settlement..........................        25,000          250       --        --          11,000           --          11,250
Stock issued related to      
   acquisition of Rose Technology......        68,150          681       --        --          24,677           --          25,358
Stock received in sale of Texcel.......       (40,000)        (400)      --        --         (93,200)          --         (93,600)
Net loss...............................           --           --        --        --            --       (4,665,654)   (4,665,654)
                                          ------------   ----------   --------  --------  ------------   ------------   -----------
Balance, December 31, 1994.............     12,242,433      122,424       --        --      30,656,889    (26,929,491)    3,849,822
Debt converted to equity (Note 11).....        700,000        7,000       --        --         443,002           --         450,002
Issuance of common stock (Note 11).....      1,278,152       12,782       --        --         688,075           --         700,857
Stock issued upon litigation
   settlement..........................          8,000           80       --        --           8,176           --           8,256
Net income.............................           --           --         --        --            --           76,265        76,265
                                          ------------   ----------   --------  --------  ------------   ------------   -----------
Balance, December 31, 1995.............     14,228,585      142,286       --        --      31,796,142    (26,853,226)    5,085,202
Issuance of stock related to
   acquisition of Cal ASIC
   (Note 3)............................      1,427,526       14,275       --        --       1,707,270           --       1,721,545
Debt converted to equity (Note 11).....        440,000        4,400       --        --         973,021           --         977,421
Stock issued upon exercise of
   warrants (Note 11)..................        474,158        4,742       --        --         644,426           --         649,168
Issuance of common stock (Note 11).....        190,000        1,900       --        --         154,100           --         156,000
Net income.............................           --           --         --        --            --          779,569       779,569
                                          ------------   ----------   --------  --------  ------------   ------------   -----------
                                            16,760,269   $  167,603       --    $   --    $ 35,274,959   $(26,073,657)  $ 9,368,905
                                          ============   ==========   ========  ========  ============   ============   ===========
</TABLE>


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


                                       29




<PAGE>   30
                              JMAR INDUSTRIES, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994



<TABLE>
<CAPTION>
                                                                                   Year ended December 31,
                                                                       ---------------------------------------------
                                                                            1996           1995            1994
                                                                       -------------   -------------   -------------
<S>                                                                    <C>             <C>             <C>           
Cash flows from operating activities:
     Net income  (loss) .............................................  $     779,569   $      76,265   $  (4,665,654)
     Adjustments to reconcile net income (loss) to net cash
      used in operating activities:
         Depreciation and amortization..............................         668,172         565,750         918,391
         Services received in exchange for
            common stock or warrants................................            --            21,056          13,757
         Restructuring charges......................................            --              --          (411,000)
         Loss on sale and disposition of assets.....................            --              --           608,671
         Loss on disposal of discontinued operations................            --              --           540,404
         Discount on payables.......................................            --              --          (348,001)
         Gain on sale of product line...............................            --              --          (496,454)
     Change in assets and liabilities net of effects of acquisitions:
          (Increase) decrease in:
          Accounts receivable......................................       (1,252,278)       (589,073)      2,360,360
          Inventories..............................................       (1,307,937)       (464,635)        (81,666)
          Prepaid expenses and other...............................         (654,320)        (31,760)         71,923
          Other assets.............................................         (132,172)       (108,350)         63,338
          Increase (decrease) in:
          Accounts payable and accrued liabilities................         1,485,279      (1,094,372)     (3,245,776)
          Discontinued operations-noncash charges and working
             capital changes.....................................              --              --          1,606,373
                                                                       -------------   -------------   -------------
     Net cash used in operating activities......................            (413,687)     (1,625,119)     (3,065,334)
                                                                       -------------   -------------   -------------
Cash flows from investing activities:
     License and patent costs....................................            (12,905)        (16,675)           --
     Capital expenditures........................................           (941,597)       (251,502)       (172,025)
     Increase in notes and other receivables.....................           (187,722)         (7,147)        (27,259)
     Payments received on notes receivable.......................          1,004,502       1,339,661         240,283
     Proceeds from sale of assets................................               --            12,498       2,770,341
     Acquisition costs, net of cash acquired.....................            (86,393)           --            44,210
     Proceeds from sale of discontinued operations...............               --              --         1,500,000
     Cash used for discontinued operations.......................               --              --           (77,262)
                                                                       -------------   -------------   -------------
          Net cash provided by (used in) investing activities....           (224,115)      1,076,835       4,278,288
                                                                       -------------   -------------   -------------
Cash flows from financing activities:
     Net borrowings (payments) under short-term debt agreements..            (82,648)        734,866        (478,681)
     Net borrowings (payments)  of notes payable.................            706,921        (313,860)     (4,231,977)
     Net proceeds from the issuance of common stock..............            156,000          19,547       4,750,479
     Net proceeds from the exercise of warrants..................            649,168            --              --
     Cash provided by discontinued operations....................               --              --           134,583
                                                                       -------------   -------------   -------------
          Net cash provided by financing
            activities...........................................          1,429,441         440,553         174,404
                                                                       -------------   -------------   -------------
Net increase (decrease) in cash and cash
  equivalents....................................................            791,639        (107,731)      1,387,358
Cash and cash equivalents, beginning of
  period.........................................................          1,837,647       1,945,378         558,020
                                                                       -------------   -------------   -------------
Cash and cash equivalents, end of period.........................      $   2,629,286   $   1,837,647   $   1,945,378
                                                                       =============   =============   =============
</TABLE>



SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITY: On May 23, 1996, the Company
acquired approximately 94 percent of the outstanding common stock of California
ASIC. As consideration for the acquisition, the Company issued an aggregate of
approximately 1,427,526 shares of its common stock (See Note 3).



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


                                       30

<PAGE>   31

                              JMAR INDUSTRIES, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.  DESCRIPTION OF THE COMPANY

         The accompanying consolidated financial statements include the accounts
of JMAR Industries, Inc. (the "Company" or "JMAR") and its wholly owned
subsidiaries. All significant intercompany balances and transactions have been
eliminated in consolidation.

         The Company develops, manufactures and markets precision measurement
and manufacturing systems and specialty semiconductor and laser products for the
microelectronics and medical industries.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

    a.   Cash and Cash Equivalents

         The Company defines cash and equivalents to include cash on hand and
cash invested in short-term securities which have original maturities of less
than 90 days.

    b.   Fair Value of Financial Instruments

         The carrying value of certain of the Company's financial instruments,
including accounts receivable, accounts payable and accrued expenses
approximates fair value due to their short maturities. Based on borrowing rates
currently available to the Company for loans with similar terms, the carrying
value of its notes payable, capital lease obligations and borrowings under the
Company's line of credit approximates fair value.

    c.   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.

    d.   Income Taxes

         The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standard No. 109 ("SFAS 109"). Under the asset and
liability method of SFAS 109, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. Under
SFAS 109, the effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Valuation allowances are established for net deferred tax assets when it is
uncertain that such tax assets will be realized.

     e.  Property and Equipment

         Property and equipment are recorded at cost. Depreciation and
amortization are provided over the assets' estimated useful life of three to ten
years using the straight-line method. Maintenance and repairs are expensed as
incurred. Costs capitalized for self constructed assets include direct material,
labor and applicable overhead.


                                       31
<PAGE>   32


                              JMAR INDUSTRIES, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


     f.  Goodwill and Other Assets

         Goodwill is amortized by systematic charges to income over the periods
estimated to be benefited, generally five to ten years. The Company periodically
reevaluates the original assumptions and rationale utilized in the establishment
of the carrying value and estimated lives of these assets. Management believes
that there has been no impairment of goodwill as reflected in the Company's
consolidated financial statements as of December 31, 1996. Accumulated
amortization of goodwill was $244,599 and $94,204 at December 31, 1996 and 1995,
respectively. Patent costs are amortized over ten years, and other assets are
amortized over not more than five years. Accumulated amortization of other
assets was $184,340 and $89,619 at December 31, 1996 and 1995, respectively.

     g.  Long-Lived Assets

         In March 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 121 ("SFAS 121") "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of", which requires the adjustment of the carrying value of long-lived assets
and certain identifiable intangibles, if their value is determined to be
impaired. The Company adopted the provisions of this standard on January 1,
1996. The adoption of SFAS 121 had no material impact on the accompanying
financial statements.

     h.  Revenues

         Product revenues are generally recognized when the product is shipped
and all risks of ownership have passed to the customer. 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. Actual costs could
differ from these estimated costs. Estimated losses are fully charged to
operations when identified.

     i.  Income (Loss) Per Share

         Income (loss) per common and common equivalent share is based on the
weighted average number of shares of common stock outstanding and dilutive
common equivalent shares from stock options, warrants and convertible notes
using the treasury stock method. Common stock equivalents are not included in
the calculation of loss per share as their effect would be antidilutive.

     j.  Stock Options

         Effective January 1, 1996, the Company adopted the disclosure only
requirement of Statement of Financial Accounting Standards No. 123 ("SFAS 123"),
Accounting for Stock-Based Compensation. The adoption of SFAS 123 had no
material impact on the accompanying financial statements (see Note 12).

     k.  Reclassifications

         Certain reclassifications have been made to the prior year financial
statements to conform with the 1996 presentation.


                                       32
<PAGE>   33



                              JMAR INDUSTRIES, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


      l.  Pervasiveness of Estimates

         The preparation of financial statements in conformity with generally
accepted accounting principles 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.

3.  ACQUISITION OF CALIFORNIA ASIC, INC.

         On May 23, 1996, the Company acquired (the "Acquisition") approximately
94 percent of the outstanding common stock of California ASIC Technical
Services, Inc., a Nevada corporation (subsequently renamed California ASIC ("Cal
ASIC")). The Acquisition involved a private tender offer to the shareholders of
Cal ASIC (the "Sellers"). As consideration for the Acquisition, the Company
issued to the Sellers an aggregate of 1,427,526 shares of its Common Stock. The
shares issued by the Company are unregistered, however, the Company agreed to
use its best efforts to register certain of the shares in the future. The
purchase price was negotiated at arm's length.

         In addition, concurrent with the closing, the Company loaned $400,000
of its funds to Cal ASIC (in addition to $100,000 previously loaned) and agreed
to loan an additional $1,000,000 over an eighteen month period, of which
$500,000 was loaned in 1996, to be used by Cal ASIC for equipment purchases and
working capital purposes. In addition, the Company agreed to loan the two
majority shareholders of Cal ASIC up to $250,000, secured by the JMAR stock they
received in the Acquisition.

         Cal ASIC is engaged in the design, fabrication, assembly and testing of
application specific integrated circuits for the electronics industry and will
be operated as a division of the Company.

         The Company has accounted for the acquisition as a purchase effective
June 1, 1996. The allocation of the purchase price of Cal ASIC reflected in the
accompanying financial statements has been prepared based upon an independent
appraisal of certain of the acquired assets and using management's estimate of
fair value for the remaining net assets. The Company will continue to review its
allocation of the purchase price to the acquired assets and liabilities.
Goodwill related to this acquisition is being amortized over five years.

         The following unaudited pro forma information gives effect to the
acquisition of Cal ASIC as if the acquisition occurred on January 1 of each
respective pro forma period. In connection with the acquisition, Cal ASIC
entered into agreements with several of its creditors which reduced the related
liabilities due those creditors by approximately $850,000. Such debt reductions
are not reflected in the statement of operations of the Company. The pro forma
loss from continuing operations excludes any impact from the debt settlements of
Cal ASIC directly attributable to the Acquisition. These statements do not
purport to be indicative of the results of operations which actually would have
occurred had the acquisition of Cal ASIC occurred on January 1 of each
respective period or which may be expected to occur in the future.


                                       33
<PAGE>   34



                              JMAR INDUSTRIES, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

<TABLE>
<CAPTION>
                                                                  For the Year Ended December 31,
                                                                  -------------------------------
                                                                  1996                       1995
                                                              -----------                ------------
<S>                                                           <C>                        <C>         
Total revenues                                                $16,343,000                $ 12,401,000
                                                              ===========                ============
                                                             
Income (loss) from continuing operations                      $   368,000                $   (304,000)
                                                              ===========                ============
                                                             
Income (loss) per share                                       $       .02                $       (.02)
                                                              ===========                ============
                                                          
</TABLE>

  4.  INVENTORIES

         At December 31, 1996 and 1995, inventories consisted of the following:
<TABLE>
<CAPTION>
                                                                                        1996             1995
                                                                                     ----------       ----------
<S>                                                                                  <C>              <C>       
Raw materials, components and sub-assemblies                                         $2,695,803       $1,333,163
Work-in-process                                                                         913,403          725,109
Finished goods                                                                          246,106          527,303
                                                                                     ----------       ----------
                                                                                     $3,855,312       $2,585,575
                                                                                     ==========       ==========
</TABLE>
                                                                                

5.  ACCOUNTS RECEIVABLE

         At December 31, 1996 and 1995, accounts receivable consisted of the 
following:
<TABLE>
<CAPTION>
                                                                                        1996                1995
                                                                                    -----------         -----------
<S>                                                                                 <C>                 <C>        
Trade                                                                               $ 2,802,417         $ 1,496,433
U.S. Government - billed                                                                 38,130              94,466
U.S. Government - unbilled                                                              171,445             169,835
                                                                                    -----------         -----------
                                                                                      3,011,992           1,760,734
Less - Reserve for doubtful accounts                                                    (17,230)            (18,250)
                                                                                    -----------         -----------
                                                                                    $ 2,994,762         $ 1,742,484
                                                                                    ===========         ===========
</TABLE>

         All unbilled  receivables  at December 31, 1996 and 1995,  are expected
to be billed and collected within one year. Payment to the Company, for
performance on certain U.S. Government contracts, is subject to progress payment
audits by the Defense Contract Audit Agency and are recorded at the amounts
expected to be realized.

6.  PROPERTY AND EQUIPMENT

         At December 31, 1996 and 1995, property and equipment consisted of the
following:


                                       34
<PAGE>   35





                              JMAR INDUSTRIES, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

<TABLE>
<CAPTION>
                                                                                      1996               1995
                                                                                  -----------         -----------
<S>                                                                               <C>                 <C>        
Equipment and machinery                                                           $ 4,243,555         $ 1,815,406
Furniture and fixtures                                                                313,909             253,211
Leasehold improvements                                                                 62,380              43,775
                                                                                  -----------         -----------
                                                                                    4,619,844           2,112,392
Less-Accumulated depreciation                                                      (1,915,384)         (1,540,770)
                                                                                  -----------         -----------
                                                                                  $ 2,704,460         $   571,622
                                                                                  ===========         ===========
</TABLE>


7.  COMMITMENTS AND CONTINGENCIES

         The Company leases office facilities under operating leases and certain
equipment and software under capital leases. Minimum future rental payments as
of December 31, 1996 are as follows:
<TABLE>
<CAPTION>
                                                         Capital Leases             Operating Leases
                                                         --------------             ----------------
<S>                                                       <C>                           <C>      
1997............................................          $ 113,388                     $ 292,378
1998............................................            113,388                       192,169
1999............................................             61,938                       127,263
2000............................................               --                            --
2001............................................               --                            --
                                                          ---------                     ---------
                                                            288,714                     $ 611,810
                                                                                        =========
Amount representing interest                                (29,317)
                                                          ---------
                                                            259,397
Less: Current portion                                       (96,527)
                                                          ---------
                                                          $ 162,870
                                                          =========
</TABLE>

         During September, 1996, the Company entered into a $950,000 lease
financing agreement with Leasing Technologies International, Inc., the proceeds
of which will be used to finance Cal ASIC equipment and software financing
requirements. The above amount for capital leases represents the amount
outstanding pursuant to that agreement at December 31, 1996.

         Related rent expense was $315,515, $260,672 and $327,741 for the years 
ended December 31, 1996, 1995 and 1994, respectively.

         In the ordinary course of business,  the Company has been involved in 
various legal proceedings and claims. Currently there are no significant legal
proceedings or claims which in the opinion of management would have a material
adverse effect on the Company's consolidated financial position or results of
operations.

8.  NOTES PAYABLE

         Notes payable as of December 31, 1996 and 1995, were as follows:


                                       35
<PAGE>   36



                              JMAR INDUSTRIES, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
<TABLE>
<CAPTION>
                                                                                   1996               1995
                                                                                ----------         ----------
<S>                                                                             <C>                <C>      
Working  capital line of credit in the amount of $3,000,000 with Comerica
Bank -  California.  Advances  are  based  on 80%  of  eligible  accounts
receivable and 35% of eligible  inventories  up to  $1,000,000.  Advances
bear  interest  at prime  plus  1.25%.  Interest  on the line is  payable
monthly;  principal is due in full on 30 day notice. Advances are secured
by all assets of PPL. The bank agreements contain covenants,  among other
items, relating to income levels and financial ratios....................      $ 1,444,281        $ 1,526,929
                                                                                

Unsecured convertible promissory notes in the amount of $600,000 and
$1,600,000 at December 31, 1996 and 1995, respectively, convertible into
160,000 shares of common stock at December 31, 1996, bearing interest at
8.25 percent, due October 1997, net of $10,369 of loan fees..............          589,631          1,536,273
                                                                                   

Note payable due in monthly principal installments of $10,417 plus interest
through October 2000, interest at prime plus 1.25%, secured by
all assets of PPL........................................................          468,749               -

Notes payable due in monthly principal and interest installments of $6,306
through May 2000, interest at 12 percent, secured by certain
machinery and equipment..................................................          218,234               -

Capital leases (see Note 7)..............................................          259,397               -

Other notes payable......................................................            4,879               -
                                                                               -----------        -----------
                                                                                 2,985,171          3,063,202

Less: Current portion....................................................       (2,317,861)        (1,526,929)
                                                                               -----------        -----------
                                                                               $   667,310        $ 1,536,273
                                                                               ===========        ===========
</TABLE>

     During October 1993 the Company issued  $2,500,000 of convertible  
promissory notes of which $600,000 remain outstanding at December 31,1996. The
convertible notes bear interest at 8.25 percent and were initially convertible
into shares of Common Stock of the Company at $3.75 per share. In March 1995,
the Company entered into an agreement to amend the terms of the notes, whereby
the conversion price for a pro-rata share of the notes (8.7 percent) was lowered
to $.40 per share and the Company would repay, without penalty, one dollar of
remaining notes for every one dollar of notes converted pursuant to the amended
conversion terms. During 1995, $200,000 in notes were converted into 500,000
shares and the Company repaid another $200,000 of the notes. During the third
quarter of 1995, the Company entered into an agreement to further amend the
terms of the notes, whereby the conversion price for a pro-rata share of the
notes (15.8 percent) was lowered to the higher of $1.50 or the average of the
closing best bid price of the Company's Common Stock for the ten trading days
prior to the day the note holder elects to convert. Pursuant to these amended
terms, holders of $300,000 in convertible notes converted the notes. In October
1996, the Company entered into an agreement to further amend the terms of the
notes, whereby the conversion price for a pro-rata share of the notes (62.5
percent) was lowered to $2.27 per share, which was the fair market value of the
Company's Common Stock at the time of the amendment. Pursuant to these amended
terms, holders of $1,000,000 in convertible notes converted the notes into
440,000 shares (see Note 11). These transactions had no impact on the Company's
results of operations for any of the


                                       36
<PAGE>   37



                              JMAR INDUSTRIES, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

periods presented in the accompanying financial statements, other than the
corresponding reduction in interest expense.

         The weighted average interest rate on the loan with Comerica
Bank-California was 9.52% and 10.07% for 1996 and 1995, respectively. The
maximum amount outstanding was $1,632,666 and $1,526,929 and the average amount
outstanding was $1,055,497 and $869,737 during 1996 and 1995, respectively.

         Interest paid for the years ended December 31, 1996, 1995 and 1994 was
$289,248, $254,648 and $491,820, respectively.

9.  RELATED PARTY TRANSACTIONS

         During 1996, the Company renewed the employment  contract with its 
Chief Executive Officer, Dr. John S. Martinez to provide for a yearly salary of
not less than $175,000 and extended the term thereof to December 31, 1999. In
1993, the Company loaned Dr. Martinez $59,000 with interest at 6% per annum to
assist Dr. Martinez in paying certain income taxes that he personally incurred
in connection with a transaction that he undertook in support of the Company.

         During 1994, the Company issued warrants to directors, officers and
employees to purchase 658,666 shares of common stock of the Company in
connection with bridge loans made to the Company. The warrants have exercise
prices per share ranging from $.36 to $.47.
                                                              
10.  INCOME TAXES

         For the year ended  December 31, 1996,  the Company has recorded a tax
benefit of $175,000 related to the estimated future utilization of net operating
loss carryforwards. No provision for federal and state income taxes has been
provided for the year ended December 31, 1995 due to the Company's carryforward
position. No provision for federal and state income taxes has been provided for
the year ended December 31, 1994 as a result of the losses incurred in that
period.

         At December 31, 1996, the Company had Federal net operating loss 
carryforwards as follows:
<TABLE>
<CAPTION>
EXPIRES
-------
<S>                                                                                              <C>    
2002 .....................................................................................   $   139,000
2003 .....................................................................................         1,000
2004 .....................................................................................     1,381,000
2005 .....................................................................................     2,840,000
2006 .....................................................................................       961,000
2007 .....................................................................................     4,546,000
2008 .....................................................................................     6,932,000
2009 .....................................................................................     6,860,000
2010 .....................................................................................     2,265,000
2011 .....................................................................................       315,000
                                                                                             -----------
Total ....................................................................................   $26,240,000
                                                                                             ===========
</TABLE>

                                       37
<PAGE>   38
                                                                                


                              JMAR INDUSTRIES, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


         The Company has approximately $1,192,000 of favorable temporary
differences that will offset future taxable income subject to the change in
ownership limitations discussed below.

         Realization  of future tax benefits from  utilization  of the net  
operating loss carryforwards for income tax purposes is limited by the change in
ownership (as defined for Federal Income Tax Reporting Purposes) as a result of
the Company's initial public offering in May 1990. As a result of additional
financings in 1992 and 1993 as discussed in Note 11, additional ownership
changes have occurred which restrict the Company's ability to utilize its net
operating loss carryforwards and any "built in losses." In addition, the net
operating losses of acquired companies are also subject to separate change of
ownership limitations. Of the above net operating loss carryforwards, annual
limitations of approximately $813,000 apply to approximately $7,088,000 of
Company and acquired company loss carryforwards. Approximately $19,152,000 of
net operating loss carryforwards are not subject to annual limitations.

         The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1996 and 1995 are presented below:

DEFERRED TAX ASSETS: 
<TABLE>
<CAPTION>
                                                                                      1996               1995
                                                                                  ------------       ------------

<S>                                                                                <C>                <C>        
Net operating loss carryforwards ...........................................       $ 8,922,000        $ 8,372,000
Losses from equity and other investments ...................................           363,000            493,000
Other ......................................................................            42,000            192,000
                                                                                   -----------        -----------
         Total gross deferred tax assets ...................................         9,327,000          9,057,000
         Less valuation reserve ............................................        (9,152,000)        (9,057,000)
                                                                                   -----------        -----------
         Net deferred tax asset ............................................       $   175,000        $         -
                                                                                   ===========        ===========
</TABLE>
                                                                             
         The valuation reserve as of December 31, 1996 represents deferred tax
assets which management believes, based on the Company's history of operating
losses, may not be realized in future periods.

         The effective income tax rate for 1996, 1995 and 1994 varied from the
statutory federal income tax rate as follows:
<TABLE>
<CAPTION>
                                                                  1996             1995            1994
                                                                  -----            -----           -----

<S>                                                                 <C>             <C>              <C>  
Statutory federal income tax (benefit) rate ...................     34%             (34)%            (34)%
State income tax ..............................................      6               (6)              (6)
Permanent differences .........................................      2               16                8
Benefit (recorded) not recorded due to net operating loss
carryforward position .........................................    (71)              24               32
                                                                   ---              ---              ---
                                                                   (29)%             --               --
                                                                   ===              ===              ===
</TABLE>
                                                                             


                                       38
<PAGE>   39




                              JMAR INDUSTRIES, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


11.  STOCKHOLDERS' EQUITY

         During October,  1993, the Company issued $2,500,000 of convertible  
promissory notes of which $600,000 remain outstanding at December 31, 1996.
During 1995, $200,000 in notes were converted into 500,000 shares and the
Company repaid another $200,000 of the notes. During the third quarter of 1995,
holders of $300,000 in convertible notes converted the notes into 200,000
shares. In October 1996, holders of $1,000,000 in convertible notes converted
the notes into 440,000 shares (see Note 8).

         During 1995 and 1994, the Company received approximately $90,000 and
$4,750,000 from private placements of Common Stock.

         During 1994,  holders of $112,956 in debt of the Company  agreed to 
convert that debt into 58,160 shares of Common Stock of the Company.

         During 1995, the Company issued 1,000,000  shares of Common Stock in 
exchange for preferred stock (the "Preferred Stock") of Atlantic American
Holding Company Limited ("Atlantic"). The investment was recorded at a cost of
$621,000 at December 31, 1995. In December 1996, the Company and Atlantic
entered into an Escrow Agreement and Agreement of Settlement and General Release
whereby Atlantic agreed to (i) an early redemption of the remaining shares of
Preferred Stock held by the Company less that portion redeemed by the receipt of
$224,500 in November 1996; (ii) the payment of all accrued but unpaid dividends
under the Preferred Stock; and (iii) the reimbursement of certain legal fees and
out-of-pocket costs incurred by the Company in connection with a civil action
(the "Civil Action") filed by the Company against Atlantic. In return, JMAR
agreed to dismiss the Civil Action and in January, 1997, JMAR received
approximately $885,000 as a final settlement from Atlantic.

         During the year ended December 31, 1996, the Company received net
proceeds of approximately $805,000 from the exercise of warrants into
approximately 474,000 shares of common stock and private placements of
approximately 190,000 shares of common stock.

         In addition to the common stock, the Company has outstanding 2,705,882
warrants which trade on NASDAQ under the symbol JMARW and which entitle the
holder to purchase one share of JMAR common stock at a price of $4.68. The
warrants, which expire on February 15, 1998, are redeemable on 30 days notice at
the Company's option if the closing high bid price of JMAR's common stock
exceeds $6.38 for a period of 20 days.

12.  STOCK-BASED COMPENSATION PLANS

         The Company has four stock  option or warrant  plans,  the 1988 Stock  
Option Plan (the "1988 Plan"), the 1991 Stock Option Plan (the "1991 Plan"), the
Management Anti-Dilution Plan (the "Anti-Dilution Plan"), and an incentive plan
which provides for the issuance of warrants to PPL employees (the "PPL Plan").
The Company accounts for these plans under APB Opinion No. 25, under which no
compensation cost has been recognized. Had compensation cost for these plans
been determined consistent with FASB Statement No. 123 ("SFAS 123"), the
Company's net income and earnings per share would have been reduced to the
following pro forma amounts:


                                       39
<PAGE>   40



                              JMAR INDUSTRIES, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

<TABLE>
<CAPTION>
                                                                 1995                       1996
                                                                 ----                       ----
<S>                         <C>                                <C>                       <C>     
Net Income:                 As Reported                        $76,265                   $779,569
                            Pro Forma                           68,337                    668,169
Primary and Fully
   Diluted EPS:             As Reported                            .01                        .05
                            Pro Forma                              .00                        .04
</TABLE>


         Because the SFAS 123 method of accounting  has not been applied to 
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that expected in future years.

         The Company may grant options or warrants to its employees (including
directors) and consultants for up to 120,000 shares under the 1988 Plan,
1,480,000 shares under the 1991 Plan, 806,637 shares under the Anti-Dilution
Plan, and 450,000 shares under the PPL Plan. As of December 31, 1996, the
Company has granted options or warrants for 115,542 shares under the 1988 Plan,
577,220 shares under the 1991 Plan, 455,230 shares under the Anti-Dilution Plan,
and 200,000 shares under the PPL Plan. Under all Plans the option or warrant
exercise price is equal to or more than the stock's market price on date of
grant. In 1996, the Company repriced 737,340 options and warrants under the 1991
Plan, the Anti-Dilution Plan and PPL Plan and changed the initial vesting period
of 655,230 of such warrants to provide for vesting on the earliest of (i) forty
five days after such time as the closing high bid price of the Company's common
stock for 20 consecutive trading days is greater than $6.38; (ii) the exercise
by the warrantholders of at least 90 percent of the Company's warrants which
currently trade on the Nasdaq NMS; or (iii) nine years and six months after the
date of grant.

         A summary of the status of the  Company's  four stock  option or 
warrant  plans at  December  31,  1995 and 1996 and  changes
during the years then ended is presented in the table and narrative below:
<TABLE>
<CAPTION>
                                                       
                                         1994                             1995                           1996
                            ------------------------------   ------------------------------  ------------------------------
                               Shares         Wtd Avg Ex        Shares         Wtd Avg Ex       Shares         Wtd Avg Ex
                                                Price                            Price                           Price
                            --------------   -------------   --------------   -------------  --------------   -------------
<S>                                <C>               <C>          <C>             <C>               <C>           <C>  
Outstanding at beg. of
   year                            920,719           $5.07        1,054,983       $4.56             993,518       $4.35
Granted                            267,500            4.25          107,000         .85             330,184        2.37
Exercised                                -               -                -           -                   -           -
Forfeited                         (133,236)           5.26         (168,465)       5.09              (4,333)       3.27
                                                                                             
                                 ---------                        ---------                       ---------
Outstanding at end of                                                                        
   year                          1,054,983            4.56          993,518        4.35           1,319,369        2.69
                                 ---------                        ---------                       ---------
Exercisable at end of                                                                        
   year                            189,775                          186,783                         261,418
Weighted average fair                                                                        
   value of options or                                                                       
   warrants granted                   1.60                              .62                            1.61
</TABLE>
                                                                                
         232,080 of the  1,319,369  options and  warrants at December 31, 1996 
have exercise prices between $.53 and $1.09, with a weighted average exercise
price of $.82 and a weighted average remaining contractual life of 7.7 years.
96,213 of these options and warrants are exercisable. 161,376 of the options and
warrants outstanding at December 31, 1996 have exercise prices between $1.79 and
$2.94, with a weighted average exercise price of $2.43 and a


                                       40
<PAGE>   41


                              JMAR INDUSTRIES, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


weighted average remaining contractual life of 8.5 years. 42,486 of these
options and warrants are exercisable. 895,304 of the options and warrants at
December 31, 1996 have exercise prices of $3.00, with a weighted average
exercise price of $3.00 and a weighted average remaining contractual life of 6.8
years. 92,110 of these options and warrants are exercisable. 30,609 of the
options and warrants outstanding at December 31, 1996 have exercise prices of
$9.00, with a weighted average exercise price of $9.00 and a weighted average
remaining contractual life of less than one year. All of these options and
warrants are exercisable.

         The fair value of each option and warrant  grant is estimated  on the 
date of grant using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1995 and 1996: risk-free
interest rates of 7 percent; expected dividend yields of 0 percent, expected
lives of 6 years, and expected volatility ranging from 70 to 98 percent
(depending on the date of grant).

13.  RESTRUCTURING CHARGES AND OTHER DISPOSITIONS

         On December 9, 1994,  the Company  completed the sale of  substantially
all of the assets of its unprofitable wholly-owned subsidiary Surgilase to
Sharplan Lasers, Inc. ("Sharplan"), a wholly-owned subsidiary of Laser
Industries Limited for a total price of approximately $6,700,000 which includes
the assumption by Sharplan of approximately $2,950,000 of liabilities and a
combination of notes and cash totaling approximately $3,750,000. Under the terms
of the transaction, the Company received $1,500,000 in cash at closing with the
balance of approximately $2,250,000 to be received in several installment
payments through June 30, 1996. Of this amount, $1,343,700 was received in 1995
and $904,889 was received in 1996.

         The loss on disposition of Surgilase has been accounted for as 
discontinued operations and prior years financial statements have been restated
to reflect the discontinuation of Surgilase. Revenues of Surgilase for 1994 were
$5,277,406.

         During 1994,  PPL sold its Flying Height Testing  ("FHT")  equipment  
product line to a wholly-owned subsidiary of Cambrian Systems, Inc. The final
sale amount was $2,400,000 which resulted in a gain of approximately $496,000
which was reported in the statement of operations for 1994.

         As part of the Company's decision to restructure and consolidate the 
manufacturing equipment group, during 1994 the Company sold several product
lines and assets of its subsidiary, Benchmark Industries, Inc. ("Benchmark"),
completed most of the consolidation of the industrial laser product line of
Benchmark into PPL and sold its Texcel subsidiary. During 1994 the Company
decided not to sell the Metrology line of PPL. Accordingly, the restructuring
reserves previously established for that potential sale were reversed in 1994.
This reversal was offset by certain additional restructuring costs associated
with the disposition and consolidation of certain assets of Benchmark.

14.  SIGNIFICANT CUSTOMERS AND EXPORT SALES

         Government contracts generated 9%, 15% and 18% of the Company's
revenues in the years ended December 31, 1996, 1995 and 1994, respectively. In
1996, three other non-government customers accounted for 29.5%, 12.1% and 10.7%
of the Company's revenues. In 1995, four non-government customers accounted for
11.0%, 11.3%, 15.8% and 16.4% of the Company's revenues. In 1994, two
non-government customers accounted for 13.3% and 10.2% of the Company's
revenues.


                                       41
<PAGE>   42

                              JMAR INDUSTRIES, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


          A summary of export sales by geographic area is as follows:
<TABLE>
<CAPTION>

                                                                        YEAR ENDED DECEMBER 31,

                                                               1996              1995              1994
                                                           -------------     --------------    --------------

<S>                                                          <C>               <C>                <C>       
Europe .........................................             $1,544,390        $   40,384         $   15,518
Asia ...........................................             $1,420,767        $1,684,083         $3,249,559
Other ..........................................             $  440,291        $   76,973         $   86,484

</TABLE>

                                       42
<PAGE>   43


ITEM 9.  CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

Not applicable

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The officers and directors of the Company are as follows:


<TABLE>
<CAPTION>
NAME                               AGE                            POSITION
----                               ---                            --------


<S>                                <C>    <C>                                                    
John S. Martinez, Ph.D.            66     Chief Executive Officer, President, Chairman of the
                                          Board and Director


Robert S. Hash                     46     President of PPL



Dennis E. Valentine                40     Vice President Finance, Chief Financial Officer, Chief
                                          Administrative Officer and Secretary


Richard M. Foster                  63     President of JTC



Edwin Barrowcliff                  59     President and Chief Executive Officer of Cal ASIC


James H. Banister, Jr.             66     Director



C. Neil Beer, Ph.D.                61     Director



Vernon H. Blackman, Ph.D.          67     Director



Barry Ressler                      56     Director



Marvin W. Sepe                     41     Executive Vice President and General Manager of Cal ASIC
                                          and Director


John P. Ricardi                    44     Vice President for Corporate Development and Senior Vice
                                          President for Sales and Marketing of PPL

</TABLE>
     The directors of the Company are elected by the shareholders to hold office
until the next annual meeting of stockholders and until their respective
successors have been elected and qualified. Officers of the Company are elected
annually by the Board of Directors and hold office until their successors are
duly elected and qualified.

     JOHN S. MARTINEZ, Ph.D., became Chairman of the Board, President, Chief
Executive Officer and a Director of the Company at its inception. Prior to
co-founding the Company in October, 1987, he was President of HLX Laser, Inc.,
an excimer laser development company and President of Jamar Enterprises, a
management and investment consultant to high-technology companies. From 1976 to
1984, Dr. Martinez was President and Chief Executive Officer of Physics
International Company ("PI"), a high-technology research, development and
manufacturing company specializing in high-intensity energy technology and X-ray
generation equipment. During that period, PI's annual sales grew from
approximately $9,000,000 to over $42,000,000 and profits grew at a compounded
annual rate in excess of 32%. From 1961 to 1976, he held a number of management
positions at TRW, Inc. He formed that company's High Energy Laser program in
1970 and managed it until he left the company in 1976. Dr. Martinez, a Ford
Foundation and Atomic Energy Commission Fellowship holder,


                                       43
<PAGE>   44


earned his Ph.D. in Engineering Science from the University of California
(Berkeley) in 1962, his Bachelor's degree from Rensselaer Polytechnic Institute
(Troy, N.Y.) in 1951 and is a graduate of the Oak Ridge School of Reactor
Technology. He served on active duty in the U.S. Marine Corps during the Korean
War and was discharged as a Captain in 1954. He is the holder or co-holder of
six patents.

     ROBERT S. HASH, was elected President, Chief Operating Officer and a
director of the Company in February, 1994. At that time he resigned as President
of PPL. Mr. Hash resigned as President, Chief Operating Officer and director of
the Company in July, 1994 and resumed the duties of President of PPL. Mr. Hash
had been the President and a director of PPL since co-founding the company in
1985. From 1977 to 1985, Mr. Hash was employed by McBain Instruments, where he
served as Special Products Manager, General Manager of Commercial Products, and
Vice President of Engineering. At McBain Instruments, Mr. Hash developed and
marketed precision opto-electronic systems, the sales of which were responsible
for the increase in revenues of that company from $500,000 in 1977 to more than
$13 million in 1984. At the time of the acquisition of McBain Instruments by
Warner-Lambert in 1983, Mr. Hash was serving as a Division Vice President.

     DENNIS E. VALENTINE, has been the Vice President-Finance of the Company
since August, 1990, Chief Financial Officer and Chief Administrative Officer
since March, 1991 and Secretary since January, 1992. Prior to joining the
Company, Mr. Valentine had over ten years of financial and management experience
with Arthur Andersen LLP. His experience at Arthur Andersen LLP included
extensive work with public companies and consultation regarding mergers and
acquisitions. He was the manager in-charge of the local office merger and
acquisition program and was on the Board of Advisors of the Orange County
Venture Forum. Mr. Valentine received a Bachelor of Science degree in Business
from the University of Southern California in 1978. He is a member of the
American Institute of Certified Public Accountants and the California Society of
Certified Public Accountants.

     RICHARD M. FOSTER,  has been the President and a director of JTC since  
January 1994. From 1984 to 1990, he was Corporate Vice President and Director of
Marketing at Physics International Co. From 1968 to 1984, he was with TRW
Defense and Electronics and was Marketing Director for a number of product lines
including communication satellite systems, high energy lasers, power and
propulsion and the Physical Research Center. Mr. Foster also spent three years
in Washington D.C. as a TRW Senior Representative. He was a principal engineer
at Ford Aeronutronic in Newport Beach from 1960 to 1968 and an Air Force Captain
at Edwards AFB Rocket Propulsion Laboratory from 1957 to 1960. Mr. Foster
graduated cum laude with a B.S. and M.S. in Engineering from Stanford University
in 1957.

     EDWIN BARROWCLIFF, is the President, Chief Executive Officer and a director
of California ASIC. Mr. Barrowcliff was a co-founder and served as President of
California ASIC since its inception in April, 1992. From 1989 to 1992 he was
Vice President and General Manager of Lasarray Corporation, Inc. where he was
responsible for technology development and demonstration of the company's
turn-key minifabrication facility for producing application specific integrated
circuits (ASICs) utilizing proprietary laser-based lithography methodology. He
served as Vice President of Operations from 1986 to 1989 at Holt Integrated
Circuits, Inc. where his responsibilities included establishing a wafer
fabrication facility suitable for producing the company's product line of
medical implantable custom integrated circuits. From 1979 to 1988 Mr.
Barrowcliff was employed by Commodore Semiconductor Systems, Inc., a division of
Commodore Computers, Inc. As project manager he was responsible for establishing
a high volume wafer fabrication facility for producing I/C parts for use in the
company's line of computers. As Vice President and General Manager of the
state-of-the-art facility he increased the staff to 400 persons and increased
production levels to in-excess of 3 million parts per month. Mr. Barrowcliff has
held a number of Engineering and Management positions at several 


                                       44
<PAGE>   45


semiconductor companies including Union Carbide, Motorola, Litton and Rockwell
International since receiving his Bachelor's degree in Physics from San Jose
University in 1966.

     JAMES H. BANISTER, JR., has been a director since December, 1989 and was a
consultant of the Company from September, 1989 until March 31, 1994. He was the
Company's Chief Financial Officer, Chief Administrative Officer and Treasurer
through March, 1991. Since October, 1993 Mr. Banister has been President, Chief
Executive Officer and a Director of Kinetic Ceramics, Inc. From August, 1987 to
June, 1988 he was President and CEO of MSI, a subsidiary of Olin Corporation
supplying Signal Intelligence and electronic warfare equipment and services.
When that company was sold by Olin, Mr. Banister retired to manage his personal
investments. Mr. Banister was with Physics International Company (which became a
subsidiary of Olin Corp. in 1985), from June, 1964 to August, 1987, successively
holding the positions of Contracts Manager, Director of Marketing and Contract
Relations, Vice President and Director of Administration and Senior Vice
President responsible for finance and administration. From 1953 to 1964, Mr.
Banister was with Stanford Research Institute, now SRI International, holding
the position of Manager of Contract Administration. Mr. Banister received a
Bachelor of Science degree in Business and Engineering administration from MIT
and has taken graduate courses in law at Golden Gate College. He has been an
officer and director of several subsidiaries of Physics International Company.

     C. NEIL BEER, Ph.D., has been a director since July, 1988 and was an
employee of the Company from May, 1991 until November, 1992 and a consultant to
the Company from April, 1993 to September, 1993. Dr. Beer currently is the
President of SECON, a software engineering company primarily supporting the
national intelligence community. Prior to that, he was the Vice President,
Advanced Programs, OAO Corporation and, prior to that, was the Colorado Space
Advocate, responsible for the growth of Colorado's space industry. From
September, 1986 to October, 1989 he was President of Thermo Technologies
Corporation which develops advanced lasers, optics, signal processing, and
energy conversion hardware. Previously he was Deputy for Strategic Defense,
Military Applications, at Livermore National Laboratory. During his career with
the U.S. Air Force, Dr. Beer achieved the rank of Major General and was deputy
Chief of Staff, plans and programs, for the Air Force Space Defense Command.
Earlier, while assigned to the office of the Secretary of Defense, he worked
with the White House staff on policy and support requirements. Dr. Beer was
associate professor of mathematics at the Air Force Academy and a combat pilot
in Southeast Asia. Dr. Beer graduated magna cum laude, with a B.S. degree in
engineering from the University of Oklahoma, and received his doctorate in
Operations Research in 1972 from that same University. Dr. Beer is recipient of
the NSIA Medal for Outstanding Achievement in Space.

     VERNON H.  BLACKMAN,  Ph.D.,  has been a director  of the Company  since  
July, 1991 and was a consultant of the Company from December, 1991 through March
31, 1994. Dr. Blackman has served as Chairman of the Board and Chief Executive
Officer of Esscor, a training and simulation service company to the utility
industry, since December, 1991. Dr. Blackman also served as Chairman of the
Board, President and Chief Executive Officer of JAYCOR from 1989 until March,
1991. JAYCOR is a high technology company which supplies R&D services to various
agencies of the U.S. Government; primarily the Department of Defense. Prior to
joining JAYCOR, Dr. Blackman acted as a venture investor for his own account and
helped to fund the early stage development of several companies. Dr. Blackman
currently serves on the Board of Directors of Digivision, a privately-held
company which provides products to the medical industry. Dr. Blackman has also
served on the Boards of Directors of several other public companies, including
Newport Pharmaceuticals International, Inc. (1967-1974); Maxwell Laboratories,
Inc. (1966-1974); Topaz, Inc. (1979-1983) at which time Topaz was acquired by
Square D Corporation; and Optical Radiation Corporation (1970-1995). From 1974
to 1982, Dr. Blackman served as President, CEO and Chairman of the Board of
S-Cubed, a high technology company which provided services and products to
agencies of the U.S. Government. In 1959, Dr. Blackman co-founded MHD Research
which was acquired by Hercules Corporation in 1964. 


                                       45
<PAGE>   46


Dr. Blackman received a BA in Physics from Colgate University in 1951 and a
Ph.D. in Physics from Princeton University in 1955, subsequent to which he
served on the faculty as a research associate for 2 years.

     BARRY RESSLER,  has been a director of the Company since January,  1994. 
Mr. Ressler is the Chief Executive Officer and Chairman of the Board of Triton
Thalassic Technologies, Inc. (T3I), a marine technology company specializing in
antifouling, water portability and industrial fluid contaminant technologies and
products. Mr. Ressler is also the President of Star Associates, Inc., a company
engaged in the basic research and development of particle accelerators and free
electron lasers for industrial and medical applications. From 1983 to December,
1993 he served as Chief Executive Officer and Chairman of the Board and a
director of Thermo Voltek, a subsidiary of Thermo Electron. From 1963 until his
appointment as CEO and Chairman, he served on various capacities at Thermo
Voltek. Mr. Ressler is a member of the Biotechnology Center External Advisory
Board of the University of Connecticut, advising the University on the expansion
of biotechnology research initiatives to foster University Industry
collaborative activities. Mr. Ressler graduated from the Pratt Institute with a
B.S. in Engineering Science.

     MARVIN W. SEPE,  has been a director of the Company  since July,  1996.  
Mr. Sepe is the Executive Vice President and General Manager of California ASIC.
Mr. Sepe comes to the Company after a 15 year tenure with TRW Components
International Inc., a wholly owned subsidiary of TRW Inc., focused on technical
services and technology transfer for the international spacecraft industry. With
strengths in international business and strategic management, Mr. Sepe was
Director of Business Development for this division of TRW, which grew from
$16,000,000 in sales to nearly $40,000,000 under his strategic direction.
Previously, Mr. Sepe held other Director positions within the company including
Marketing, Programs and Engineering. Mr. Sepe was a key member of a team of TRW
executives tasked with evaluating TRW technology developments and determining
the suitability of those developments for business spin-offs. Prior to joining
TRW, Mr. Sepe was responsible for the development and oversight of multiple
semiconductor manufacturing operations both in the U.S. and internationally. Mr.
Sepe held the position of Manager of Worldwide Assembly Operations for Silicon
General Inc. (1980-1981) with contract manufacturing operations throughout
Southeast Asia, as well as the U.S. This producer of linear semiconductors
produced over 1.5 million devices per month through its worldwide operations.
Mr. Sepe came to Silicon General after performing the same role for Silicon
Systems Inc. (1977-1980), a fast growing start-up operation for custom
semiconductors. His experience with semiconductors also includes management
responsibilities with Hi-Rel Laboratories (1974-1977), a well respected
evaluation laboratory. Mr. Sepe attended Don Bosco Technical Institute,
California Polytechnic State University SLO, and holds a Masters Degree in
Business Administration from Pepperdine University. Mr. Sepe has published a
number of papers and taught numerous workshops on the economics and use of
semiconductors in space applications.

     JOHN P. RICARDI, joined the Company in February, 1997. Mr. Ricardi is the
Company's Vice President for Corporate Development and Senior Vice President for
Sales and Marketing of PPL. He brings more than 20 years of related industry
experience to the Company, having served in numerous management positions with
various responsibilities for product development, national and international
sales and marketing and engineering operations. Most recently, he was Vice
President, General Manager of the Imaging Systems Division of Datron/Transco,
Inc. and Vice President, Marketing for Datron/Transco Inc. a subsidiary of
Datron Systems, Inc. His background also includes eight years with North
American Phillips Corporation as corporate Director of Marketing of its Airpax
subsidiary and seven years with Texas Instruments Inc. He holds a master of
science degree in electrical engineering from Northeastern University in Boston.


                                       46
<PAGE>   47


ITEM 11.  EXECUTIVE COMPENSATION

         The following table sets forth the annual and long-term compensation
for services in all capacities to the Company during each of the last three
fiscal years of the Company's Chief Executive Officer and two other executive
officers of the Company (collectively, the "Named Officers"). No other executive
officer received more than $100,000 in annual salary and bonuses during 1996.

                           Summary Compensation Table
<TABLE>
<CAPTION>
                                                                                        Long-Term Compensation
                                                    Annual Compensation (1)                   Awards (2)
                                              --------------------------------------------------------------------
     Name and               Year                 Salary                 Bonus           Securities Underlying
Principal Position                                 ($)                 ($)(3)          Options and Warrants (#)
------------------------------------------------------------------------------------------------------------------
<S>                         <C>                  <C>                   <C>                     <C>     
John S. Martinez,           1996                 170,184               83,369                  384,622 (5)
Chief Executive             1995                 150,000               15,552                   55,000
Officer                     1994                 163,079                  0                      2,500
                                                                                       

Robert S. Hash,             1996                 150,350               38,785                  150,000 (5)
President of PPL            1995                 153,234                  0                        0
                            1994                 150,000                  0                    160,000 (4)
                                                                                               
                                                                                               
Dennis E.                   1996                  98,065               33,347                   67,595 (5)
Valentine,                  1995                  90,000                6,221                   20,000
Chief Financial             1994                  89,165                  0                        0
Officer                                                                                      
</TABLE>

(1)  Excludes perquisites and other personal benefits, the aggregate annual
     amount of which for each Named Officer was less than the lesser of $50,000
     or 10% of the total salary and bonus reported.

(2)  The Company did not grant any restricted stock or stock appreciation rights
     or make any long term incentive plan payments during the fiscal years ended
     December 31, 1996, 1995 and 1994.

(3)  Includes  bonus payments  earned by the Named  Officers in the year 
     indicated for services rendered in such year, but which were paid in the
     following year.

(4)  Includes 150,000 incentive warrants issued in 1994 to Mr. Hash pursuant to
     the incentive program established in 1993 at the time PPL was acquired by
     the Company.

(5)  Includes 324,420, 150,000 and 42,393 options and warrants for Messrs.
     Martinez, Hash and Valentine, respectively, which were granted and reported
     in prior years, but which were amended on August 15, 1996 to reduce their
     respective exercise prices to $3.00 per share, 20 percent over the trading
     price on NASDAQ on August 15, 1996.


                                       47
<PAGE>   48


OPTION GRANTS IN THE LAST FISCAL YEAR

         The following  table sets forth each grant of stock options and 
warrants made during the fiscal year ended December 31, 1996 to each of the
Named Officers:
<TABLE>
<CAPTION>
                                                       PERCENTAGE OF
                                                       TOTAL OPTIONS
                                SHARES UNDERLYING        GRANTED TO       
                                 OPTIONS GRANTED        EMPLOYEES IN       EXERCISE PRICE
NAME                                (SHARES)             FISCAL YEAR         PER SHARE        EXPIRATION DATE (2)
------------------------------ -------------------- -------------------- ----------------- -------------------------

<S>                               <C>                      <C>                <C>          <C> 
John S. Martinez                  50,000 (1)(3)            4.68               $1.09        January 15, 2006
                                  5,000 (1)(4)(8)           .47               $2.62        September 20, 2006
                                   2,601 (1)(4)             .24               $3.00        June 5, 2006
                                 2,601 (1)(4)(8)            .24               $2.62        September 23, 2006
                                     325,420               30.38              $3.00        (7)

Robert S. Hash                     150,000 (7)             14.05              $3.00        March 24, 2004

Dennis E. Valentine               20,000 (1)(6)            1.87               $1.09        January 15, 2006
                                   2,601 (1)(4)             .24               $3.00        June 5, 2006
                                  2,601 (1)(4)(8)           .24               $2.62        September 23, 2006
                                     42,393                3.98               $3.00        (7)
</TABLE>

---------------------------
(1)  Such options were all granted under the Company's 1991 Stock Option Plan.
     The exercise price of shares covered by such stock options may not be less
     than the fair market value of the Company's common stock at the date of
     grant. The terms of each such option and the increments in which it is
     exercisable are determined by the Board of Directors. The exercise price
     and tax withholding obligations related to exercise may be paid by delivery
     of already owned shares or by the offset of the underlying shares, subject
     to certain conditions.

(2)  Options also expire if not exercised within 60 days after termination of
     optionee's employment or one year following death of optionee if not
     exercised by optionee's personal representative or one year following
     resignation as a director.

(3)  These options are incentive stock options.  27,333 of these options are 
     currently exercisable and the balance become exercisable on January 15,
     1998.

(4)  These options are non-qualified stock options. These options become
     exercisable and vest one-third each year commencing on the first year after
     their grant.

(5)  These options are incentive stock options. These options become exercisable
     and vest one-third each year commencing on the first year after their
     grant.

(6)  These options are incentive stock options.  10,933 of these options are 
     currently exercisable and the balance become exercisable on January 15,
     1998.

(7)  These options and warrants were granted and reported in prior years but
     were amended on August 15, 1996 to reduce their respective exercise prices
     to $3.00 per share, 20 percent over the trading price on NASDAQ on August
     15, 1996. The expiration dates of such options and warrants remain
     unchanged and range from March 28, 2001 to March 31, 2003.

(8)  These options contain a Reload Option feature whereby if the optionee
     exercises the option in whole or in part using shares of Common Stock owned
     by the optionee for at least six months, the Company shall grant to the
     optionee a Reload Option to purchase that number of shares equal to the
     shares transferred to the Company in payment of the exercise price of the
     option.


                                       48
<PAGE>   49


AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR END OPTION VALUES

         The following table sets forth for each of the Named Officers the
shares acquired and the value realized on each exercise of stock options, if
any, awarded to said officers as additional compensation during the fiscal year
ended December 31, 1996 and the number of shares of common stock underlying
options and warrants outstanding at December 31, 1996 and the value of such
options and warrants which are "in-the-money":
<TABLE>
<CAPTION>
                                                        SHARES UNDERLYING              VALUE OF
                                                           UNEXERCISED               UNEXERCISED
                                                           OPTIONS AND          IN-THE-MONEY OPTIONS AND
                                                           WARRANTS AT                WARRANTS AT
                               SHARES                    DECEMBER 31, 1996        DECEMBER 31, 1996 (1)
                              ACQUIRED                   -----------------        ---------------------
                                 ON          VALUE         EXERCISABLE/               EXERCISABLE/
NAME                          EXERCISE      REALIZED       UNEXERCISABLE              UNEXERCISABLE
------------------------------------------------------------------------------------------------------------

<S>                             <C>           <C>         <C>                       <C>     
John S. Martinez                0             0           61,809/391,669            $61,772/$104,690

Robert S. Hash                  0             0             --/150,000                     --

Dennis E. Valentine             0             0            33,098/54,497             $21,845/$40,646
</TABLE>

---------------------------

 (1)     Options are "in-the-money" if the fair market value of the underlying
         common stock exceeds the exercise price of the option or warrant at
         December 31, 1996. The fair market value of a share of common stock at
         December 31, 1996 was $2.375 per share as quoted on the NASDAQ Stock
         Market at the close of trading.

EMPLOYMENT AND CONSULTING AGREEMENTS

         Pursuant to Dr. Martinez's employment agreement, the Company agreed to
retain him as Chief Executive Officer of the Company and to pay him an annual
salary of not less than $175,000 plus expenses and normal employee insurance
benefits and a $600 per month auto lease allowance. The term of the employment
agreement continues until December 31, 1999. If the employment agreement is
terminated by the Company without cause, Dr. Martinez would become entitled to
receive as severance pay an amount equal to the greater of 36 month's pay or the
balance of the compensation that would have been payable to Dr. Martinez under
the employment agreement.

INCENTIVE PLANS

         In February, 1993, the Board of Directors of the Company approved the
Management Anti-Dilution Incentive Plan (the "Plan") for the Company's senior
management. The Plan was designed to provide senior management with an incentive
to maximize stockholder value. Pursuant to the Plan, the executive officers and
directors of the Company, together with Dr. Shields, JTC's Chief Scientist, were
issued warrants ("Incentive Warrants") to purchase an amount of Common Stock
which, at the time of issuance of the warrants, would bring each participant's
percentage ownership of Common Stock closer to the percentage such participant
owned prior to the completion of the Company's public offering in February,
1993. An aggregate of 455,230 Incentive Warrants were outstanding on December
31, 1996. The Incentive Warrants expire sixty days following the termination of
the holder's employment with the Company if such Incentive Warrants are not then
exercisable. The Incentive Warrants terminate three years following the date
such warrants are first exercisable or, in any event, ten years from the date of
issuance. The Company has agreed that if it files a Registration Statement or a
post-effective amendment to a Registration Statement following the date on which
the Incentive Warrants are 


                                       49
<PAGE>   50


exercisable, the holders of the Incentive Warrants shall have the opportunity to
register or qualify the shares of Common Stock underlying the Incentive Warrants
for offering to the public at no cost to such holders.

         In connection with the acquisition of PPL by the Company in October,
1993, the Company established an incentive plan for the key employees of PPL
which provides for the issuance of warrants (the "PPL Warrants") to purchase up
to 450,000 shares of Common Stock. As of December 31, 1996, warrants to purchase
up to 200,000 shares of Common Stock have been granted to Mr. Hash and Leonid
Yoffe. The PPL Warrants have substantially the same terms as the Incentive
Warrants.

         Prior to August 15, 1996, both the Incentive Warrants and the PPL
Warrants were not exercisable until such time as the average of the closing high
bid prices of the Common Stock as reported on NASDAQ or NASDAQ-NMS, as the case
may be, during any consecutive 180 day period was equal to or greater than
$8.50. Upon becoming exercisable, the Incentive Warrants and PPL Warrants were
then exercisable at a per share exercise price of $5.10. On August 15, 1996, the
Board of Directors approved an amendment to the Incentive Warrants and the PPL
Warrants to provide that the warrants will not be exercisable until the earlier
of (i) forty five days after such time as the closing high bid price of the
Common Stock for 20 consecutive trading days is greater than $6.38 (which is
150% of the offering price of the Company's 1993 public offering); (ii) the
exercise by the warrantholders of at least 90 percent of the Company's warrants
which currently trade on the Nasdaq National Market System under the symbol
JMARW; or (iii) nine years and six months after the date of grant. Upon becoming
exercisable, the Incentive Warrants and PPL Warrants will be exercisable at a
per share exercise price of $3.00, which represents a price equal to 20 percent
over the closing price of the Company's shares as quoted on the NASDAQ-NMS on
August 15, 1996.

DIRECTORS' FEES

         Effective April 1, 1994, Directors who are not salaried employees of
the Company receive a retainer (the "Retainer") of $1,000 per quarter and $500
for their attendance at each Board of Directors meeting and Committee meeting
and are reimbursed for their travel, lodging and food expense incurred when
attending such meetings.

         In addition, the 1991 Stock Option Plan, as amended, provides that
directors are eligible to participate in the 1991 Stock Option Plan on the same
basis as key employees of the Company and grants of options will be made by the
Board of Directors on a case-by-case basis on such terms as the Board in its
discretion may provide. During the fiscal year ended December 31, 1996, a grant
of options to purchase 5,000 shares of Common Stock was received by those
directors who had served more than one year (Messrs. Martinez, Banister, Beer,
Ressler and Blackman) and a grant of options to purchase 10,000 shares of Common
Stock was received by Mr. Sepe in their capacity as directors.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following table sets forth, as of March 3, 1997, certain
information regarding the beneficial ownership of the Company's Common Stock by
(1) each person or entity known to the Company to be the beneficial owner of
more than five percent of the Company's Common Stock, (2) each director of the
Company, (3) each of the Named Officers, and (4) all directors and executive
officers of the Company as a group. In all cases, unless otherwise indicated,
the named person has sole voting power and sole investment power over the
securities.


                                       50
<PAGE>   51


<TABLE>
<CAPTION>
                                                NUMBER OF SHARES OF                       PERCENTAGE OF
                                                    COMMON STOCK                    OUTSTANDING COMMON STOCK
           BENEFICIAL OWNER                      BENEFICIALLY OWNED                    BENEFICIALLY OWNED
           ----------------                      ------------------                    ------------------

<S>                                                  <C>                                      <C>  
John S. Martinez (1)                                 1,558,992                                8.94%

Robert S. Hash (2)                                    294,802                                 1.74%

Marvin W. Sepe (3)                                    146,269                                  (8)

Dennis E. Valentine (4)                               106,652                                  (8)

James H. Banister, Jr. (5)                             47,629                                  (8)

Vernon H. Blackman (6)                                 20,833                                  (8)

Barry Ressler (6)                                      18,336                                  (8)

C. Neil Beer (6)                                       11,082                                  (8)

All executive officers and directors
as a group (10 persons) 
(7)                                                 3,042,720                               16.81%
</TABLE>

---------------------------
 (1)  Includes: (a) 372,965 shares owned of record by the John S. Martinez
      Separate Property Trust, of which Dr. Martinez as trustee, has sole voting
      and investment power; (b) 586,027 shares of Common Stock which are
      issuable upon exercise of currently exercisable warrants and stock
      options; and (c) 600,000 shares of Common Stock subject to a voting
      agreement pursuant to which Dr. Martinez has sole voting power (but no
      investment power) until the earlier of October 6, 2003 or until the
      transfer of the shares according to the terms of the voting agreement (the
      "Voting Agreement"). 100,000 shares were released from the Voting
      Agreement in 1996 and are no longer included in the shares beneficially
      owned by Dr. Martinez. Dr. Martinez also holds sole voting power pursuant
      to the Voting Agreement over 160,000 shares of Common Stock which are
      issuable upon conversion of $600,000 of notes. Pursuant to the terms
      thereof, since these notes are not convertible within 60 days of the date
      of this Form 10-K, Dr. Martinez is not considered to have "beneficial
      ownership" of said 160,000 shares.

(2)   Includes: (a) 239,234 shares received by Mr. Hash in connection with the
      acquisition of PPL by the Company; (b) 45,980 shares which are issuable
      upon exercise of currently exercisable warrants and; (c) 9,588 shares
      which are issuable upon exercise of currently exercisable warrants owned
      of record by Mr. Hash's wife.

(3)   Includes 144,068 shares which are issuable upon exercise of currently 
      exercisable warrants.

(4)   Includes 104,647 shares which are issuable upon exercise of currently
      exercisable stock options and warrants. 

(5)   Includes 39,229 shares which are issuable upon exercise of currently 
      exercisable stock options and warrants.

(6)   All shares are issuable upon exercise of currently exercisable stock 
      options and warrants.

(7)   Includes 1,242,163 shares which are issuable upon exercise of currently 
      exercisable stock options and warrants.

(8)   Less than one percent.


                                       51
<PAGE>   52


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         On March 29, 1993, the Company loaned Dr. Martinez $59,000 with
interest at 6% per annum to assist Dr. Martinez in paying certain income taxes
that he personally incurred in connection with a transaction that he undertook
in support of the Company. The December 31, 1996 loan amount, including accrued
interest, is $73,824. The loan is secured by 14,750 shares of Common Stock owned
by Dr. Martinez.


                                     PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)      The following documents are filed as a part of this Report:

1.       Financial  Statements.  A list of financial statements is contained in 
         "Index to Consolidated Financial Statements" on page 25 hereof.

2.       Financial Statement Schedules. The following financial statement
         schedule of JMAR Industries, Inc., for the years ended December 31,
         1996, 1995 and 1994 is filed as part of this Report and should be read
         in conjunction with the Consolidated Financial Statements of JMAR
         Industries, Inc.

Schedule

          II.  Valuation and Qualifying Accounts

          Schedules not listed above have been omitted because they are not
applicable or are not required or the information required to be set forth
therein is included in the Consolidated Financial Statements or Notes thereto.

3.       Exhibits.  The Exhibits listed on the accompanying index to Exhibits 
         are filed as part of this Report.

EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS:

         The Company's 1988 Stock Option Plan (Exhibit 10(l) to Registration
Statement 33-32446).

         The Company's 1991 Stock Option Plan, with amendments  (Exhibits A to 
Proxy Statements for 1991, 1992, 1993, 1995 and 1996 Annual Meetings of
Shareholders).

         Management Anti-Dilution Incentive Plan, as amended (Exhibit 10.12 to
this Form 10-K).

         Amended and Restated Employment  Agreement between the Company and John
S. Martinez, dated May 1, 1996 (Exhibit 10.3 to this Form 10-K).

         Management Incentive Plan Agreement for Pacific Precision Laboratories,
Inc., as amended (Exhibit 10.24 to this Form 10-K).

(b)    Reports on Form 8-K.

         There were no reports filed on Form 8-K during the three months ended
December 31, 1996.


                                       52
<PAGE>   53



                              JMAR INDUSTRIES, INC.
                           ANNUAL REPORT ON FORM 10-K
                          YEAR ENDED DECEMBER 31, 1996
                                INDEX TO EXHIBITS

3.1 (1)(3)    Articles of Incorporation and amendments thereto.

3.2(10)       Amendments  to Articles of  Incorporation,  filed on July 9, 1992,
              December 11, 1992, January 11, 1993 and February 1, 1993.

3.3 (1)       Bylaws and amendments thereto.

3.4 (13)      Amendment to Certificate of Incorporation, filed on August 23, 
              1994.

4.1 (4)       Form of Common Stock Certificate.

4.2 (4)       Form of Warrant Certificate for Warrants sold in February, 1993.

9.1 (13)      Voting Trust Agreement, dated October 6, 1993 between John S. 
              Martinez and Cato Portfolio, A.G.

10.1          Employment Agreement between California ASIC, Inc. and Marvin W. 
              Sepe, dated July 1, 1996.

10.2          Employment Agreement between California ASIC, Inc. and Edwin 
              Barrowcliff, dated May 23, 1996.

10.3          Amended and Restated Employment Agreement between the Company and
              John S. Martinez, dated May 1, 1996.

10.4 (1)      The Company's 1988 Stock Option Plan.

10.5 (1)      Form of Invention and Secrecy Agreement.

10.6 (3)      Form of Warrant,  with attached Piggyback  Registration  Rights  
              provisions, issued in April, 1991 to John S. Martinez, James H.
              Banister, Jr., C. Neil Beer, Jay Borker, Scott Love, A. Lee
              Morsell, Vernon H. Blackman, Susan Miller-French, Lester Levy and
              Ali M. M. Mojdehi.

10.7 (2) (8) (9) (12) (14) The Company's 1991 Stock Option Plan, as amended.

10.8 (5)      Underwriters' Warrants,  dated February 24, 1993, issued to 
              Commonwealth Associates ("Commonwealth") and Lew Lieberbaum &
              Co., Inc. ("Lieberbaum").

10.9 (5)      Warrant  Agreement,  dated  February  16, 1993,  among the 
              Company, Commonwealth, Lieberbaum and American Securities
              Transfer, Incorporated.

10.10 (5)     Underwriting Agreement, dated February 16, 1993, among the 
              Company, Commonwealth Associates and Lieberbaum.

10.11         Building Lease, dated August 21, 1996, between The Manufacturers 
              Life Insurance Company and the Company.

10.12         Management Anti-Dilution Incentive Plan, as amended.

                                       53
<PAGE>   54
<TABLE>
<CAPTION>
EXHIBIT NO.
                    DESCRIPTION
------------        -----------------------------

<S>           <C>                                  
10.13 (6)     Form of 8.25% Senior Subordinated Convertible Promissory Note dated October 6, 1993 issued to Cato Portfolio A.G.

10.14         Employment Agreement between Pacific Precision Laboratories, Inc. and John P. Ricardi, dated February 3, 1997.

10.15 (7)     Revolving  Credit Loan  Agreement,  dated October 6, 1993,  by and among PPL and  Comerica Bank -  California;  
              Security Agreement between PPL and Comerica; Guaranty executed by the Company.

10.16 (10)    Warrants  for the  purchase of an  aggregate  of 180,000  shares of Common  Stock,  issued to H.I.G.  Securities,  
              Ltd., Brentwood Financial, Ltd., Tesoma Overseas, Inc., Llewellyn Capital Management Ltd. and Sparta Capital, Ltd.

10.17 (10)    Form of 1994 Warrant, between the Company and Baytree Associates, Inc. for the placement of the shares in 10.16.

10.18 (13)    Form of Warrant, with attached Piggyback Registration Rights provisions issued to John S. Martinez,  Vernon H. 
              Blackman, Robert S. Hash,  Larry M. Levy,  Dennis E. Valentine,  Barry Ressler,  Leonid Yoffe and Carole Hash issued 
              in connection with the Company's August, 1994 Loan Program.

10.19 (11)    Subscription Agreement by and between the Company and Atlantic American Holding Company Limited dated March 31, 1995.

10.20(15)     Agreement of Purchase and Sale of Assets dated as of May 23, 1996,
              by and among the Company, Nancy Schwalbe, Edwin Barrowcliff and
              California ASIC Technical Services, Inc.

10.21 (16)    Master Lease Agreement and related documents dated as of September 10, 1996 between Leasing Technologies  
              International, Inc., the Company and California ASIC Technical Services, Inc.

10.22 (16)    Installment Note dated September 1, 1996 between Comerica Bank-California and Pacific Precision Laboratories, Inc.

10.23         Escrow Agreement and Agreement of Settlement and General Release
              by and among the Company; Atlantic American Holding Company
              Limited; Parker, Milliken, Clark, O'Hara & Samuelian; and Sankary
              & Sankary.

10.24         Management Incentive Plan Agreement for Pacific Precision Laboratories, Inc., as amended.

22.1          Subsidiaries of the Company  include JMAR Technology Co. (a California  corporation),  Pacific  Precision  
              Laboratories, Inc. (a California corporation) and California ASIC, Inc. (a Nevada corporation).

23            Consent of Independent Public Accountants.
</TABLE>
------------------------------------

                                       54
<PAGE>   55
<TABLE>

<S>    <C>                                                                 
(1)    Incorporated by reference to the exhibit filed with the Company's
       Registration Statement on Form S-1 (No. 33-32446) filed on December 5,
       1989 and amended on January 30, 1990, March 30, 1990 and April 23, 1990,
       which Registration Statement became effective May 11, 1990.
(2)    Incorporated by reference to the exhibit filed with the Company's Proxy Statement for the 1991 Annual Meeting of 
       Shareholders.
(3)    Incorporated by reference to the exhibit filed with the Company's Form 10-K for the year ended December 31, 1991.
(4)    Incorporated by reference to the exhibit filed with the Company's  Registration  Statement on Form S-1 (No.  33-47390) filed
       on April 22, 1992 and amended November 23, 1992, January 11, 1993, January
       27, 1993, February 9, 1993, February 11, 1993, February 12, 1993 and
       declared effective on February 16, 1993.
(5)    Incorporated by reference to the exhibit filed with the Company's Form 10-K for the year ended December 31, 1992.
(6)    Incorporated by reference to the exhibit filed with the Company's Form 10-Q for the quarter ended September 30, 1993.
(7)    Incorporated by reference to the exhibit filed with the Company's Form 8-K dated October 6, 1993.
(8)    Incorporated by reference to the exhibit filed with the Company's Proxy Statement for the 1992 Annual Meeting of 
       Shareholders.
(9)    Incorporated by reference to the exhibit filed with the Company's Proxy Statement for the 1993 Annual Meeting of 
       Shareholders.
(10)   Incorporated by reference to the exhibit filed with the Company's Form 10-K for the year ended December 31, 1993.
(11)   Incorporated by reference to the exhibit filed with the Company's Form 10-Q for the quarter ended March 31, 1995.
(12)   Incorporated by reference to the exhibit filed with the Company's Proxy Statement for the 1995 Annual Meeting of 
       Shareholders.
(13)   Incorporated by reference to the exhibit filed with the Company's Form 10-K for the year ended December 31, 1994.
(14)   Incorporated by reference to the exhibit filed with the Company's Proxy Statement for the 1996 Annual Meeting of 
       Shareholders.
(15)   Incorporated by reference to the exhibit filed with the Company's Form 8-K dated May 23, 1996.
(16)   Incorporated by reference to the exhibit filed with the Company's Form 10-Q for the quarter ended September 30, 1996.
</TABLE>

                                       55
<PAGE>   56


SIGNATURES

Pursuant to the requirement of Section 13 or 15 (d) 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 INDUSTRIES, INC.
<TABLE>
<S>                                 <C>                               
Date: March 14, 1997                By: /s/ John S. Martinez
      --------------                   ---------------------
                                            John S. Martinez
                                            Chairman of the Board and
                                            Chief Executive Officer
</TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
                SIGNATURE                          TITLE                        DATE
                ---------                          -----                        ----


<S>                                        <C>                            <C> 
/s/ John S. Martinez                       Chairman of the                March 14, 1997
-----------------------------              Board, Chief                   --------------
    John S. Martinez                       Executive Officer and
                                           Director
                           
  
  


/s/ Dennis E. Valentine                    Chief Financial                March 14, 1997
-----------------------------              Officer and Chief              --------------
    Dennis E. Valentine                    Accounting Officer
  
  


/s/ James H. Banister, Jr.                 Director                       March 12, 1997
-----------------------------                                             --------------
    James H. Banister, Jr.


  
  


/s/ C. Neil Beer                           Director                        March 12, 1997
-----------------------------                                              -------------- 
    C. Neil Beer
  
  


/s/ Vernon H. Blackman                     Director                        March 12, 1997
-----------------------------                                              --------------            
    Vernon H. Blackman
  
  


/s/ Barry Ressler                          Director                        March 12, 1997
-----------------------------                                              --------------
    Barry Ressler

  
  

/s/ Marvin W. Sepe
-----------------------------              Director                        March 14, 1997
    Marvin W. Sepe                                                         --------------

  
  
</TABLE>

  

                                       56
<PAGE>   57
                                                                     SCHEDULE II



                                    JMAR INDUSTRIES, INC.
                        VALUATION AND QUALIFYING ACCOUNTS
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994


<TABLE>
<CAPTION>
                                                            Additions
                                                    --------------------------
                                        Balance at   Charged to                                Balance at
Description                             Beginning    Costs and                                   End of
                                          of Year     Expenses       Other         Deductions     Year
                                       ----------   ---------     ------------      ---------   ----------
<S>                                    <C>           <C>          <C>               <C>         <C>       
For the year ended December 31, 1996:
  Warranty reserve ..................  $   14,729    $   --       $       --        $      71   $   14,800
  Reserve for inventory obsolescence      171,573        --            (52,597)            --      118,976
  Allowance for doubtful accounts ...      18,250        --               --           (1,020)      17,230
                                       ----------   ---------     ------------      ---------   ----------
For the year ended December 31, 1995
  Warranty reserve ..................  $   36,548   $    --       $       --        $ (21,819)  $   14,729
  Reserve for inventory obsolescence      136,403      (4,900)          47,283         (7,213)     171,573
  Allowance for doubtful accounts ...      57,000        --            (38,750)            --       18,250
                                       ----------   ---------     ------------      ---------   ----------
For the year ended December 31, 1994:
  Warranty reserve ..................  $   82,273   $  54,811     $    (26,923)(A)  $ (73,613)  $   36,548
  Reserve for inventory obsolescence    1,441,640     (64,755)      (1,240,482)(B)         --      136,403
  Allowance for doubtful accounts ...      66,595     117,000          (20,000)(A)   (106,595)      57,000
                                       ----------   ---------     ------------      ---------   ----------
</TABLE>


(A)     Existing reserves for Surgilase when sold.

(B)     Includes disposal of inventory previously reserved and existing reserves
        for Surgilase when sold.