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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-K þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2004 or o
    
    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 Technologies, Inc. 
  Delaware
    
    68-0131180(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 5800 Armada Drive, Carlsbad, CA
    
    92008(Address of principal executive offices)
    
    (Zip code)
 Registrants telephone number, including area code: (760) 602-3292 Securities registered
pursuant to Section 12(b) of the Act: Title of each class
    
    Name of each exchange on which registered
 Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value 
 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 þ No o 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. þ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). Yes o No þ




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TABLE OF CONTENTS  PART IItem 1. BusinessItem 2. PROPERTIESItem 3. LEGAL PROCEEDINGSItem 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART IIItem 5. MARKET FOR THE REGISTRANTS COMMON STOCK AND RELATED SHAREHOLDER MATTERSItem 6. SELECTED CONSOLIDATED FINANCIAL DATAItem 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSItem 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAItem 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREItem 9A. CONTROLS AND PROCEDURESPART IIIItem 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTItem 11. EXECUTIVE COMPENSATIONItem 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED            STOCKHOLDER MATTERSItem 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSItem 14. PRINCIPAL AUDITOR FEES AND SERVICESPART IVItem 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-KSIGNATURESIndex to ExhibitsEXHIBIT 10.9EXHIBIT 10.10EXHIBIT 10.12EXHIBIT 10.19EXHIBIT 10.20EXHIBIT 10.21EXHIBIT 10.22EXHIBIT 10.23EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1    Table of Contents  The aggregate market value of common stock held by non-affiliates of the Registrant as of
June 30, 2004 was $59.6 million. The aggregate market value was based on the closing price on June
30, 2004 for the common stock as quoted on the NASDAQ SmallCap Market, multiplied by the number of shares
outstanding on June 30, 2004, excluding the common stock held by executive officers, directors and
stockholders whose ownership exceeds 5% of the common stock outstanding at June 30, 2004. Exclusion
of such shares should not be construed to indicate that any such person possesses the power, direct
or indirect, to direct or cause the direction of the management or policies of the Registrant or
that such person is controlled by or under common control with the Registrant. Number of shares outstanding of common stock: Common Stock, $.01 Par Value  35,179,282 shares
as of March 25, 2005. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrants Definitive Proxy Statement for the 2005 Annual Meeting of
Stockholders to be held on June 17, 2005, and to be filed with the Commission pursuant to
Regulation 14A within 120 days after Registrants fiscal year ended December 31, 2004, are
incorporated by reference into Part III of this Report. 2




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PART I 
 Item 1. Business General JMAR
Technologies, Inc. (JMAR or Company) is a leading innovator in the development of laser-based
equipment for imaging, analysis and fabrication at the nano-scale. The Company is leveraging over a
decade of laser and photonics research to develop a diverse portfolio of products with commercial
applications in rapidly growing industries while continuing to carry out research and development
for the U.S. Defense Advanced Research Projects Agency (DARPA) and support for the U.S.
Governments Defense Microelectronics Activity (DMEA) semiconductor fabrication facility. JMAR is
targeting the nanotechnology, bioscience and semiconductor industries with its
BritelightTM Laser; X-ray Light Source; Compact X-ray Microscope  for 3D visualization
of single cells and polymers; and its X-ray Nano Probe  enabling interaction, analysis and
materials modification at the nano-scale. JMAR also develops, manufactures and markets its
BioSentryTM microorganism early warning system and maintains a strategic alliance for
the production of the READ chemical sensor for homeland security, environmental and utility
infrastructure industries. During 2004, JMAR implemented its new business strategy to balance, diversify and expand its
revenue base through new product development and technology acquisition. We are now complementing
our progress in product development and market validation with preparation for manufacturing and
distribution. Business Segments JMAR conducts its operations in the following four business segments: Research Division (formerly JMAR Research)  Located in San Diego, California, this
segment carries out contract research and development involving JMARs patented high brightness,
short-pulse, diode pumped solid state lasers (Britelight) and laser-produced plasma (LPP)
technology. A major portion of the Research Divisions R&D has been funded by contracts from DARPA
of the U.S. Department of Defense. This segments historic focus on X-ray lithography light source
R&D and equipment development was expanded in 2004 when it embarked on an effort to identify
additional uses for its laser and LPP technologies. As a result of this business expansion
investigation, this segment is developing several soft X-ray enabled products including a Compact
X-ray Microscope and a family of instruments for nanotechnology applications. JMAR believes that
this instrument family will provide the ability to carry out chemical analysis, chemical vapor
deposition, and machining at resolutions down to 20nm. During 2004, this segment accounted for
approximately 35% of the Companys revenues. New products are developed at the Research Division based on contract and internally funded
R&D and then transitioned to JMARs Vermont Operations for product engineering and production. Vermont Operations (formerly JSAL) Located in South Burlington, Vermont, this segment
carries out contract research and development involving nanolithography and serves as JMARs
manufacturing arm, carrying out the manufacturing engineering, production, integration and test of
JMARs new products. The Vermont Operations also applies its program management, engineering and
manufacturing expertise to the contract development and production of new products using the
customers technology. As an example, the Vermont Operations is the design and manufacturing
contractor for FemtoTrace, Inc. building the READ trace chemical sensors for real time detection of
extremely small quantities of organics. The READ equipment has uses in environmental contamination
detection and homeland security applications. The Vermont Operations will also introduce a novel
Optical Angular Scanning Imaging System (OASIS) for biological, medical and materials research
applications in 2005. OASIS is a versatile, rapid scanning optical microscope that combines high
magnification, fine optical resolution, and rapid 3




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scanning motion control. This segment also performs funded contract research and development for
DARPA. During 2004, this segment accounted for approximately 28% of the Companys revenues. Microelectronics Division (formerly JMAR Semiconductor)  This segment provides
process integration and maintenance support for the Defense Microelectronics Activitys
semiconductor fabrication facility in McClellan, California. It also designs and produces
application specific integrated circuits (ASICs) for military and commercial markets and is
developing application specific standard products. During 2004, this segment accounted for
approximately 37% of the Companys revenues. Sensor Products Group  This segments first product is the BioSentryTMsensor, a laser-based early-warning system that provides continuous, real-time
surveillance, detection and classification of waterborne microorganisms. Prospective applications
include beverage bottling quality assurance, water utility operations, cruise ship water monitoring
and homeland security for building water supply and water distribution systems. During 2004, there
were no revenues from this segment. Revenues are expected in 2005. Products and Services JMARs products and services evolve from one or more of its five core competencies: high
brightness solid state lasers, laser produced plasma generators for soft X-ray light, automated
precision positioning and alignment systems, microelectronic fabrication operations, and
multi-angle light scattering for particle classification. These competencies form the basis for
JMARs contract research and development, standard and custom products, and support services
revenues. BritelightLasers JMARs patented diode pumped solid state (DPSS) Britelight lasers feature high brightness,
high beam quality and sub-nanosecond rise time. High brightness DPSS lasers are well suited to a
wide variety of applications including plasma production; micromachining and welding; analytical
instruments for biotechnology and chemistry; laser identification, detection, and ranging (LIDAR);
laser crystal conditioning; and missile defense. High brightness DPSS ND:YAG lasers may be
operated at their fundamental wavelength of 1064 nm or at harmonic multiples (532 nm or 355 nm) of
the fundamental, depending on the application. Compact Soft X-ray Sources JMARs LPP X-ray Source is a compact alternative to a large synchrotron facility for certain
soft X-ray applications, including X-ray microscopy, X-ray nano probes and X-ray lithography.
JMARs LPP X-ray Source consists of a laser driver and a soft X-ray generator. The laser may be any
one of several configurations of JMARs Britelight lasers. The generator manages the target
material upon which the laser light impinges to create a plasma point source of short wavelength
(1-4 nanometer) light. The generator also collects and manages the plasma produced X-rays and
controls the debris generated by the plasma. Compact X-ray Microscope During 2004, JMAR started developing X-ray microscope (XRM) technology based on the Companys
LPP X-ray source. This development is aimed at new products enabling two dimensional (2D) imaging
and three dimensional (3D) visualization of hydrated single cells and polymers at sub-50 nanometer
resolution using X-ray tomography. At radiation wavelengths between 2-4 nm, most biological systems
produce inherent absorption contrast due to the difference in absorption between carbon and oxygen. Several XRM systems exist on synchrotron beam lines around the world and are used for imaging
biological and other specimens. JMARs innovation is to replace the synchrotron with a compact
X-ray 4




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source, making the tool available to a large number of biological or cellular research
laboratories, thereby accelerating research. The microscope, though simple in principle, is
challenging in practice due to the extremely small features being imaged. Zone plate optics are
used to collect and focus the soft X-ray light and an X-ray sensitive CCD camera is used as a
detector. Key product development milestones for the XRM include LPP target optimization, design of the
X-ray generator, and fabrication of the zone plate condenser optics. JMAR has established a
scientific advisory board (SAB) to provide guidance on the design, development and application of
the Companys XRM. We expect that the contributions from the SAB members during XRM development
will ensure that we address industry needs while continuing to meet our production milestones. We
plan to conduct first demonstrations of XRM performance during 2005. JMAR has established the basis
for an alliance with a federally funded national research center to facilitate a joint technical
exchange and to prepare for initial operation characterization and demonstration of the Alpha Model
of its X-ray microscope in early 2006. Compact X-ray Nano Probe During 2004, we began development of our X-ray Nano Probe (XNP) instrument product line for
materials analysis, machining, and deposition to 20 nanometer resolution. This instrument line uses
the same X-ray source as the XRM. We believe that the XNP will have broad application across a
number of industries including nanotechnology, chemical, and materials. The XNP system takes advantage of the high peak power and excellent beam quality produced by
our Britelight laser. LPP generated X-rays are produced in very short pulses and can be focused
using zone plates to produce nano-scale spot sizes on the target. The small spot size, in
combination with high peak power, produces power densities in excess of those required to form a
nano-plasma. Optical radiation emitted from the nano-plasma can be used in the spectroscopic
identification of materials on a 20-50 nm spatial scale. Alternatively, ions produced in the plasma
can enable nano-scale materials analysis using time of flight mass spectroscopy. We believe that
the XNP system can also be used for erosion and for deposition onto samples at
nano spatial scales. We expect to conduct first demonstrations of XNP performance in 2005. Collimated Plasma Lithography (CPL) The semiconductor industry currently uses deep ultraviolet (DUV) lithography in its chip
manufacturing process. X-ray lithography has three important attributes that differentiate it from
DUV lithography: shorter wavelength (~1 nm vs. ~193 nm), larger depth of field (~2,000 nm vs. ~150
nm), and the ability to penetrate thick resist without high absorption. These attributes make X-ray
lithography particularly well suited for printing fine features on wafers lacking smooth topology
(e.g., compound semiconductor wafers, such as GaAs), and for printing very deep, high aspect
features (e.g., C-RAM circuits). To distinguish its X-ray lithography technology from that which
uses a synchrotron, JMAR calls its technology collimated plasma lithography (CPL). Manufacturers of
compound semiconductors currently use electron beam tools to produce high aspect features. JMAR
believes its CPL technology can achieve throughput five to ten times greater than that possible
using electron-beam lithography. In 2004, JMAR demonstrated the operation of CPL using its LPP X-ray source and X-ray stepper
in a series of iron man tests. Nevertheless, it became clear that CPL faced a daunting set of
challenges and risks involving the technology, product design, manufacturing cost, infrastructure
readiness, industry momentum, financing, and competition from substitute lithography technologies.
If GaAs chip producers dramatically increase IC production in the future, X-ray lithography may
present a significant business opportunity for JMAR. Although the anticipated large demand for
X-ray lithography for GaAs semiconductor fabrication has not yet materialized, we have found other,
more immediate, applications for our laser and X-ray technology, namely the XRM and XNP products
discussed above. In addition, the Companys lithography expertise is being used to develop a zone
plate manufacturing capability for its XRM and XNP products. 5




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BioSentryTM JMARs BioSentryTM product is an early-warning system that provides continuous,
real-time surveillance, detection and classification of waterborne microorganisms. In early 2004,
JMAR formed an alliance with The LXT Group to develop the BioSentry technology. In February 2005,
the Company entered into an exclusive license with The LXT Group covering certain intellectual
property related to the BioSentry system. In late 2004 and early 2005, JMAR also entered into
exclusive license agreements with the National Aeronautics and Space Administration and with
PointSource Technologies, LLC to secure and enhance additional related technology. JMAR is currently testing and evaluating BioSentry beta units and assembling the marketing,
production, system installation, and customer support teams needed for product launch. We received
a high level of interest at the BevExpo trade show in late September 2004 from prospective buyers
in some of our target markets and we installed our first Beta test units shortly before the end of
the first quarter of 2005. In early March 2005, we entered into a Technology Testing and Contingent
Purchase Agreement with Olivenhain Municipal Water District (OMWD) for the installation and testing
of three Beta units of the BioSentry system at OMWDs water treatment plant in San Diego County. If
the BioSentry units satisfy certain test criteria during a six month test period, including
approval by the California Department of Health Services, OMWD has agreed to purchase three
BioSentry production units. The Company is also actively negotiating agreements for Beta
installations with potential customers in other key markets including homeland security, water
bottlers, cruise ships, and beverage production. Microelectronics Process Integration  Services and Fabless Production JMAR provides technology development and high-value technology services to a government
semiconductor producer. This business is based on a contract originally awarded to the Company by
General Dynamics Advanced Information Systems (GDAIS) in 1998. Work under this contract includes
the development, construction, and operation of a semiconductor wafer fabrication facility in
McClellan, California for the Defense Microelectronics Activity (DMEA). Under this ongoing program, JMAR applies its in-depth semiconductor industry experience and
relationships to define and acquire the technologies and semiconductor equipment needed to support
its customers mission. In a unique arrangement, JMAR maintains access to use DMEA facilities to
support ASIC commercial design and wafer fabrication. In 2003, JMAR expanded its relationship with
the DMEA by entering into a five-year cooperative research and development agreement (CRADA). This
CRADA establishes a joint DMEA/JMAR research laboratory environment to strengthen and enhance
DMEAs ability to use new processes, equipment, and designs to improve low volume foundry
efficiency. By virtue of this CRADA, JMAR intends to use the versatile facilities and capabilities
available at the DMEAs foundry to develop and produce commercial products for the government and
commercial sectors. READ Sensor Systems Under an agreement with FemtoTrace, Inc. (a company formed to commercialize technology
licensed from the Jet Propulsion Laboratory (JPL)), JMARs Vermont Operations is engaged in the
design and manufacture of alpha and beta sensor systems that will be used in certain environmental
applications and that have potential to meet urgent homeland security needs. This sensor system
uses a mass spectrometer-based technology named reversal electron attachment detection (READ)
developed by FemtoTrace. If the READ product meets technical and sales objectives, JMAR expects to
enter into an agreement with FemtoTrace to provide for the exclusive manufacture of production
units of this highly sensitive, real-time organic chemical detection system at JMARs Vermont
facility. OASIS Developed by JMARs Vermont Operations to address a market need for a versatile, rapid
scanning optical microscope, OASIS beta systems will be field tested in the second quarter of 2005
at the 6




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University of Vermont Microscopy Center. By combining high magnification, fine optical
resolution, and rapid scanning software, OASIS offers an affordable screening system for bioscience
applications in pathology, hematology, histology, parasitology, and mycology. Other potential
markets include forensic science, materials inspection and academic research. Markets Britelight Lasers Applications for short pulse DPSS lasers include materials science, analytical instruments,
research instruments (e.g., laser radar), and laser manufacturing applications such as modification
and cleaning, vapor deposition, etching, ablation and micro-machining. Our Britelight laser has
been applied to leading edge applications including biological mass spectrometry, optical
parametric oscillator technology, and the conditioning of crystals used in ultra high power lasers.
Although JMAR has had limited sales of Britelight lasers to date, we are now offering this laser
system to the market packaged as discrete modules or as a complete, integrated system to better
match specific customer requirements and budgets. We are also expanding our sales and marketing
efforts to reach prospective buyers within governmental agencies including the Department of
Defense and Homeland Security, National Research Laboratories, universities and other scientific
research activities. Compact Soft X-ray Source Sources of soft X-ray light are limited to the approximately 30 synchrotron facilities
worldwide. JMARs LPP based soft-X-ray source provides an alternative source that may cause some of
the current niche applications for X-rays to grow into an attractively large market. Potential
applications for the Companys soft X-ray source include 1) physics and life sciences research; and
2) industrial applications such as X-ray spectroscopy, X-ray scattering and protein
crystallography. Potential buyers include research centers, universities, industrial research
laboratories, and semiconductor equipment suppliers. Compact X-ray Microscope X-ray
microscopy markets include the fields of biology (e.g. hydrated whole cell imaging, proteomics),
polymer research, and magnetics. JMAR is targeting the XRM toward biological and materials (e.g.
polymer and drugs) tomography applications as a complement to transmission electron microscopes
(TEM). Transmission electron microscopy with tomography is difficult and costly because electron
absorption limits sample thickness to about 1 micron, requiring preparation of multiple subject
samples. During the TEM sample preparation process, data is often corrupted or lost. The XRM should
obviate the need for complex sample preparation, increasing the speed with which tomography can be
carried out. The TEM market is estimated at $200 million per year, suggesting the general magnitude
for the XRM market. Universities and research labs, some of which may be associated with hospitals, are customers
for biological research tools, such as the XRM. We believe that the XRM will enable research
facilities worldwide to rapidly carry out X-ray microscopy in their own facilities. In the field of
polymer and drug analysis and discovery, prospective customers include chemical companies,
materials companies, universities, and research labs. We expect the
addressable market size for the XRM to be
approximately $100 million in 2009. We believe that the participation of the key industry
professionals on the Companys SAB will not only materially contribute to our development efforts
but will provide JMAR invaluable insight into targeted XRM applications and markets. Compact X-ray Nano Probe Based on the Companys recent market research, we have identified four potential market
segments for the X-ray Nano Probe: semiconductor inspection, nanotechnology diagnostic instrumentation,
nanostructure prototyping, and materials research. In addition, we believe that the markets for XNP
can expand to biology, chemistry and physics applications. 7




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Collimated Plasma Lithography (CPL) Semiconductors are manufactured using a variety of substances, with the predominant substrate
being silicon. Other substances, often referred to as compound semiconductors, are used for
certain, specific applications, such as for ultra-high speed communications. The compound
semiconductor material used most frequently for these high-speed chips is Gallium Arsenide (GaAs).
GaAs is used principally for military communications equipment, but it also finds applications in
the telecommunications industry. Critical layers in many of these high-speed chips are currently
patterned using electron beam (e-beam) systems. We believe that CPL offers dramatically increased
GaAs wafer throughput, as compared to direct write e-beam lithography. The growth rate of the GaAs market declined significantly due to the unexpected downturn in
the telecom industry. As a result, the anticipated requirement for increased throughput offered by
the Companys CPL systems has been delayed. JMAR is closely monitoring signs for a market recovery
and is prepared to address this market if and when it occurs. BioSentry The BioSentry sensor is designed to provide continuous, real-time, on-line surveillance of
water for detection and classification of a variety of pathogens. Presently, drinking water from
both utilities and water bottlers is batch-sample tested for harmful pathogens on a periodic basis.
The samples are sent to laboratories for analysis and results are typically obtained in 24 to 48
hours, allowing potentially contaminated water to be consumed or requiring possibly unnecessary
preventable decontamination. The BioSentry is a compact, moderately priced early warning system that is expected to be of
value to the drinking water industry, water bottlers, food and beverage processors, and managers of
facilities (e.g. government buildings, sports arenas, large commercial buildings, etc.). In
addition, the BioSentry may be used for water surveillance at pharmaceutical and semiconductor
fabrication facilities to improve product yields and quality. We anticipate other applications will
develop as the BioSentry gains market exposure and acceptance and as the library of detectable
pathogens expands. We believe that the markets for this product are substantial. For example, there are
approximately 57,000 water treatment utilities in the United States, of which 3,000 have greater
than 100,000 customers. In addition, there are approximately 1,500 U.S. bottled water plants and
89,000 buildings greater than 100,000 square feet. We believe each of these markets provides
significant sales opportunities and that the potential total
addressable market exceeds $500 million per
year. Microelectronics Process Integration  Services and Fabless Production During 2004, the Microelectronics Division received $3.5 million in new contracts from GDAIS,
a DMEA prime contractor, to enhance the performance of the semiconductor fabrication process at the
DMEA installation. The Company expects to receive another approximately $4.2 million in contracts
early in 2005 to further this effort into 2006. The market for technology services for customers like GDAIS and DMEA is limited. JMAR
believes that this part of its revenue base will not expand significantly beyond its current level. READ Sensor Systems JMAR believes that this sensor system may have broad applications in homeland security,
commercial and defense markets including detection of environmental pollutants, explosives,
narcotics, and antibiotics. JMAR is working with FemtoTrace to define and quantify these segments
and plans to play a continuing role as a contract manufacturer of these systems. 8




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Competition Britelight Laser Among a large number of laser manufacturers, large and small, JMAR occupies a specialized
niche for high brightness, short pulse, high beam quality DPSS lasers. Competitors with products
closest to Britelight include Cutting Edge Optronics and Lambda Physik. Although JMAR believes its
Britelight lasers have competitive advantages over lasers sold by its competitors, JMAR has sold
only a few Britelight lasers to date. Large laser companies like Spectra Physics and Coherent are
not likely to enter JMARs laser niche. Soft X-ray Source Approximately 30 synchrotron facilities worldwide provide researchers and other customers with
access to soft X-rays. Although these facilities offer potential competition to the Companys X-ray
sources, we believe that the cost, limited access and lack of flexibility of these large facilities
make synchrotrons an undesirable alternative for many of the soft X-ray applications JMAR is
targeting. Two major universities in Colorado are developing soft X-ray sources using different
technical approaches. Several companies manufacture micro-focus X-ray sources for the research
community, but micro-focus X-rays offer only very low power levels and are of limited use for many
of the soft X-ray applications JMAR is targeting. Compact X-ray Microscope Competition for the XRM will come from manufacturers of substitute products that produce XRM-like images without the use of synchrotrons. Micro-focus systems from CSIRO claim to achieve
projection XRM using a micro spot source without an objective lens. This approach requires a sample
to be in close proximity to the X-ray source with the disadvantages of debris contamination and
heating of the cryogenically cooled sample. Hard X-ray systems using phase
contrast also represent possible competition, although the water window associated with the
inspection of biological samples presents a serious challenge to this approach. X-ray Nano Probe Manufacturers of focused ion beam technologies could become competitors if they can accomplish
the difficult task of achieving higher power in a smaller beam size.
Well-engineered ion beam
products already exist in the marketplace. BioSentry Presently, the BioSentry sensor has no direct competitors, but we envision that large
suppliers of monitoring devices to the U.S. drinking water industry will begin to present
competition within two years after the BioSentry is launched. Indirect competition includes the
suppliers of complex water filtration systems and expensive ultraviolet disinfection systems. Microelectronics Process Integration  Services and Fabless Production Microelectronics Division has few competitors in the market for microelectronics fabrication
services to aerospace and government entities. Although it currently is dependent upon a single
customer, the success of the Microelectronics Division in this market is due to the breadth of its
semiconductor process technology expertise and its long held relationships with top suppliers of
relevant technology and support. The programs that the Microelectronics Division performs for its
customer involve high-level engineering, labor-intensive activities requiring in-depth knowledge,
and complete understanding of the processes and technologies to be installed. Major government
contractors generally do not pursue this 9




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type of work because it requires the application of specialized, highly skilled labor, not
leveraged by subsequent high volume production. Customers and End Users For fiscal years 2004, 2003 and 2002, the United States Government accounted for approximately
54%, 69% and 68%, respectively, of total sales. A major portion of the Companys government
contract sales involves research and development aimed at producing commercially-viable products
and technology. Britelight Laser JMAR has added Lawrence Livermore National Laboratories and Wonkwang University in Korea as
Britelight laser customers and expects additional orders from these and similar customers needing
the unique features offered by Britelight. BioSentry We expect the Sensor Products Group to launch the BioSentry products into the bottled drinking
water, utility water, cruise ship, homeland security, and food and beverage processing markets in
2005. Production ramp-up is planned for the third quarter of 2005. Advanced Semiconductor Lithography JMARs advanced lithography development program has benefited from the investment of more than
$62 million in Department of Defense (DoD) funds over the past decade on its lithography light
source and an additional approximately $22 million investment in DoD funds for stepper development
at SAL prior to JMARs acquisition of SAL. These contracts were primarily managed by the U.S. Army
Research Laboratory, sponsored by DARPA. The
Company expects no further funding under this contract. In addition, in May 2002, the Company was awarded a $10 million contract by Naval Air Warfare
Center AD (Navair Contract) to procure sub-100 nm feature size X-ray
masks used in the
development and production of high performance GaAs monolithic microwave integrated
circuits (MMICs), and to produce Zone Plate optics. The Company received $2.1 million in funding in
2004 related to this contract and expects that this contract will be extended in 2005 for an
additional two years and an additional contract award of $5 million. The Company also believes that
it will receive approximately $2.8 million of this expected new funding later in 2005. Microelectronics Process Integration  Services and Fabless Production JMAR receives contracts for its microelectronics support from GDAIS, a prime contractor for
the DMEA. The Company received $3.5 million in contracts in 2004 for this program and expects
approximately $4.2 million in contracts extending through 2006. READ Sensor Systems The FemtoTrace/JMAR alliance expects to deliver the first READ Beta unit sensor systems to New
York Citys Consolidated Edison in 2005. In 2003, the Company received a $1 million contract from
FemtoTrace to design, develop and manufacture the first of these sensor systems. During 2004, the
Company recognized $600,000 in revenue related to this contract. During 2005, the Company expects
to receive an order for another Alpha unit and several Beta units. JMAR is also working with
FemtoTrace to market the READ system to other utilities, as well as to government agencies. 10




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Manufacturing JMAR has sufficient facilities and staff to manufacture BioSentry, X-ray sources, READ sensor
systems, and other products at its South Burlington, Vermont facility. JMAR believes that it will
be able to expand such facilities in Vermont as needed as its product lines become successful. The
Vermont staff has a demonstrated core competence in small volume production of complex products.
This base of production competence was developed initially from lithography systems manufacturing. Production competence at JMARs Vermont Operations spans motion control, position sensing, CPL
subsystem integration, X-ray subsystem integration, electrical and electronic systems, and the
software development competence to integrate and test complex products and systems. Motion control competence spans stepper technology for micron scale movement. Knowledge and
use of piezo-electric technology has expanded our motion capability to micron/nano scale motion.
Position sensing with optics and lasers has been developed to the nano scale. With these unique
skill sets added to our experience with CPL, X-ray and electronic/electrical subsystems, we believe
that our Vermont facility is prepared to support the production launch of BioSentry, XRM and XNP. The major challenge in 2005 is for the Vermont facility to start up and meet production
demands for BioSentry and READ, as well as other new products in the pipeline. We believe that our
core competencies in optics, electrical/electronic subsystems, software and integration are core
skills which facilitate the technical content of production start up. The medium volumes and the complex multiple product mix complexity of these new products
impose significant challenges to the successful production of our new products. To address these
challenges, we are establishing cellular manufacturing and pull systems (for production control)
and building the other infrastructure needed for production and ramp up. Included in this infrastructure improvement is the introduction of a new ERP system in
2005. This tool-set will link production with marketing, sales and finance giving real time access
to the factorys capability to serve (lead-time) and accurate product cost upon which to set price. The Company depends on third party suppliers for components used in the development and
manufacture of our products. If certain key components are delayed or unavailable, we might have to
reengineer our products, resulting in delays and increased costs, or we may have to pay other
suppliers more to obtain those components, which could adversely affect our business. In addition,
our cost models contemplate that multiple suppliers and greater volume purchases will bring down
the manufacturing costs to make our new systems more competitively priced. Although we anticipate having multiple sources of supply for the components used in
our future production systems, there are no assurances that additional suppliers will materialize.
In particular, our XRM and XNP products require certain X-ray optics called zone plates that are
difficult and expensive to manufacture. We have identified suppliers of zone plates and have also
initiated an effort to manufacture zone plates in-house. If we cannot obtain these zone plates when
needed at an acceptable cost, then we will need to rely on other optics, which would involve
additional re-engineering and related delays and additional costs which could adversely affect our
business. Our BioSentry product development effort also relies on certain complex optics, such as a
holographic optical element. If we cannot obtain these optics when needed at an acceptable cost,
then we may have to redesign the product, which would involve additional re-engineering and related
delays and additional costs which could adversely affect our business. 11




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Sales and Marketing To date, JMARs sales and marketing effort has been focused on obtaining research and
development contracts and microelectronics production support opportunities from the Department of
Defense. In November 2004, the Company hired David McCarty as our new Vice President of Business
Development to manage our marketing efforts directed toward commercial markets relevant to our new
BioSentry, XRM and XNP products. Mr. McCarty brings extensive marketing and sales skills and, in
particular, has extensive experience and contacts in all BioSentry target markets. Among Mr.
McCartys first priorities will be to work with the Vice President of the Sensor Products Group to
promote the BioSentry and establish both sales and distribution systems worldwide. Research and Development The majority of JMARs R&D effort has been carried out under contracts from the U.S.
Department of Defense. This work focuses on solving technology problems of importance to the United
States because of defense needs or critical industrial base considerations. JMAR also carries out
independent research and development (IR&D) in areas of interest to the DoD. IR&D is included in
the rate structure associated with government contracts. Finally, JMAR funds technology and product
development work intended to grow the Company through new products and an expanded customer base.
In 2004, JMAR increased its investment in this last category above historic levels as it focused on
the development of new products with attractive commercial market potential. Company-funded expenditures for research, development and engineering (RD&E) were $1,722,329,
$529,039, $854,306, $602,980 and $340,227 for the years ended December 31, 2004, 2003, 2002, 2001
and 2000, respectively. Total expenditures for RD&E, including funding provided by third party
contracts from the U.S. government and other companies, were $5,716,191, $10,135,784, $12,383,221,
$7,638,266 and $4,151,767 for the years ended December 31, 2004, 2003, 2002, 2001 and 2000,
respectively. Since
January 2004, the Company received $13.5 million in financing from various institutional
investors. JMAR has been using a portion of these funds to initiate and advance new product
research and development efforts and to acquire or license products and technologies that support
its BioSentry, XRM and XNP product lines. Intellectual Property Rights JMARs patent protection efforts have resulted in the issuance of 18 U.S. patents and 6
foreign patents. JMAR currently has filed 6 pending U.S. patent applications, 15 pending foreign
applications and 11 provisional patent applications. The issued patents contain numerous claims
covering various types of laser plasma X-ray sources, high-brightness solid state lasers,
point-source lithography system technology, advanced collimator technology, improved X-ray source
chambers, improved laser amplifiers, internal imaging of semiconductor devices (nanotomography),
laser ablation of materials, ultraviolet and EUV microlithography systems and X-ray lithography
stepper technology, each of which represents an opportunity for growth for JMAR. The expiration
dates of these patents range from 2010 to 2023. Because the later issued patents cover many of the
fundamental aspects of the earlier patents, with more recent improvements, the more recently issued
patents are generally more important than the earlier patents. Some of the more recent pending and
provisional applications cover aspects of the X-ray Microscope and X-ray Nano Probe products. In 2004 and 2005, JMAR entered into exclusive licenses with NASA, PointSource Technologies,
LLC and The LXT Group covering technology, including issued U.S. patents and pending patent
applications, necessary or useful for our BioSentry products. 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 12




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##### Table of Contents



locked out of the use of its own technology by other patents. However, 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 each of our products are in areas that 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. Employees Currently, the Company has approximately 50 full-time employees. The Company is not subject to
any collective bargaining agreements and believes that it maintains excellent relations with its
employees. INFORMATION REGARDING INDUSTRY SEGMENTS, SIGNIFICANT CUSTOMERS AND EXPORT SALES The Company operates in four segments as follows: Research Division, Vermont Operations,
Microelectronics Division and Sensor Products Group. Financial information relating to the
Companys segments, significant customers and export sales for the three years ended December 31,
2004 is incorporated by reference from Note 13 of Notes to Consolidated Financial Statements. 
 Item 2.PROPERTIES The Company has a total of approximately 83,231 square feet of laboratory, office,
manufacturing and storage space under leases between the Company or its subsidiaries and their
respective landlords. The Companys corporate headquarters occupies 4,856 square feet in Carlsbad,
California approximately 35 miles north of San Diego International Airport. This lease expires on
September 30, 2005. The Research Division leases 9,280 square feet located in the Sorrento Valley region of San
Diego, 15 miles north of San Diego International Airport. The Sorrento Valley space is used for the
Companys advanced technology development activities, including Britelight, XRM, XNP and CPL. That
lease expires on April 30, 2006. The Sensor Products Group leases 2,200 square feet of office space in Escondido, California on
a month-to-month basis. The Company intends to consolidate its corporate headquarters, Research Division and Sensor
Products Group into a single facility in Northern San Diego County in
the second half of 2005 and is pursuing the lease of an
approximately 25,000 square foot facility. The Microelectronics Division leases 2,567 square feet of office and storage space in
Sacramento, California. That lease expires in May, 2006. The Microelectronics Division is
pursuing leasing additional space in its existing facility. The Systems Division leases a total of 13,767 square feet of office, manufacturing, clean room
and storage space in South Burlington, Vermont. That lease expires on March 31, 2006. The Company sold JPSI in July 2003 and its operations are reflected as a discontinued
operation. The Company is a party to a lease of the facility used by JPSI. This facility consists
of a total of 25,005 square feet of manufacturing, office and storage space in Chatsworth,
California, a suburb of Los Angeles. The facility lease expires in August, 2005. In connection with
the sale of JPSI, the buyer assumed 14 of the remaining 25 months of this lease. The Company is a guarantor on a lease of 25,556 square feet of office and storage space in
Irvine, California south of Los Angeles which was used by the standard chip business of JMAR 13




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##### Table of Contents



Semiconductor, Inc., which was discontinued in March 2002. This lease expires on August 31,
2005. The Company is currently working with the landlord to lease the space and to be released from
the lease prior to its expiration. 
 Item 3.LEGAL PROCEEDINGS None. 
 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 is traded on the Nasdaq SmallCap Market under the symbol JMAR. The
2004 and 2003 high and low transaction prices for the common stock as reported by NASDAQ are set
forth in the following table. Common Stock Price High
    
    
    Low2004First Quarter
    
    
    4.72
    
    
    
    1.96Second Quarter
    
    
    3.70
    
    
    
    1.75Third Quarter
    
    
    2.14
    
    
    
    1.03Fourth Quarter
    
    
    2.13
    
    
    
    1.272003First Quarter
    
    
    1.25
    
    
    
    0.76Second Quarter
    
    
    1.49
    
    
    
    0.82Third Quarter
    
    
    2.55
    
    
    
    1.10Fourth Quarter
    
    
    2.51
    
    
    
    1.31
 As of March 7, 2005, there were approximately 10,400 holders of JMARs common stock. 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. 14




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##### Table of Contents



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 the Companys independent registered
public accounting firm, Grant Thornton LLP. 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 2001 and 2000 have been adjusted from that previously reported to reflect the operations of
JMAR Precision Systems, Inc. and the standard chip business of JMAR Semiconductor, Inc. as
discontinued operations. Consolidated Statements of Operations Data  For the Years Ended December 31, 2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Revenues
    
    $
    10,059,839
    
    
    $
    17,296,508
    
    
    $
    18,383,810
    
    
    $
    12,903,811
    
    
    $
    9,114,357Gross profit
    
    
    1,998,740
    
    
    
    3,964,627
    
    
    
    3,413,492
    
    
    
    3,499,243
    
    
    
    2,328,406Operating expenses
    
    
    6,752,545
    
    
    
    5,383,251
    
    
    
    6,523,346
    
    
    
    4,989,402
    
    
    
    3,222,903Loss from operations
    
    
    (4,753,805
    )
    
    
    (1,418,624
    )
    
    
    (3,109,854
    )
    
    
    (1,490,159
    )
    
    
    (894,497
    )Realized gain on sale of
marketable securities
    
    
    
    
    
    
    
    
    
    
    1,349,721
    
    
    
    1,189,273
    
    
    
    2,184,476Interest and other income
    
    
    158,144
    
    
    
    63,225
    
    
    
    67,404
    
    
    
    252,282
    
    
    
    273,626Interest and other expense
    
    
    (821,586
    )
    
    
    (731,315
    )
    
    
    (284,174
    )
    
    
    (107,950
    )
    
    
    (106,466
    )Income (loss) from continuing
operations before income taxes
    
    
    (5,417,247
    )
    
    
    (2,086,714
    )
    
    
    (1,976,903
    )
    
    
    (156,554
    )
    
    
    1,457,139Income tax expense
    
    
    
    
    
    
    
    
    
    
    (484,423
    )
    
    
    
    
    
    
    Income (loss) from continuing
operations
    
    
    (5,417,247
    )
    
    
    (2,086,714
    )
    
    
    (2,461,326
    )
    
    
    (156,554
    )
    
    
    1,457,139Loss from operations of
discontinued operations
    
    
    (214,893
    )
    
    
    (1,396,749
    )
    
    
    (5,839,367
    )
    
    
    (14,544,980
    )
    
    
    (2,681,904
    )Gain (loss) on disposal of discontinued
operations
    
    
    
    
    
    
    205,000
    
    
    

    (3,200,000
    )
    
    
    
    
    
    
    Net loss
    
    
    (5,632,140
    )
    
    
    (3,278,463
    )
    
    
    (11,500,693
    )
    
    
    (14,701,534
    )
    
    
    (1,224,765
    )Preferred stock dividends
    
    
    (2,247,876
    )
    
    
    (942,903
    )
    
    
    
    
    
    
    
    
    
    
    Loss applicable to common stock
    
    
    (7,880,016
    )
    
    
    (4,221,366
    )
    
    
    (11,500,693
    )
    
    
    (14,701,534
    )
    
    
    (1,224,765
    )Basic income (loss) per share:Income (loss) per share from
continuing operations
    
    $
    (0.25
    )
    
    $
    (0.12
    )
    
    $
    (0.11
    )
    
    $
    (0.01
    )
    
    $
    0.06Loss per share from
discontinued operations
    
    
    (0.01
    )
    
    
    (0.04
    )
    
    
    (0.38
    )
    
    
    (0.64
    )
    
    
    (0.12
    )Loss per share applicable to
common stock
    
    $
    (0.26
    )
    
    $
    (0.16
    )
    
    $
    (0.49
    )
    
    $
    (0.65
    )
    
    $
    (0.06
    )Basic shares used in computation of
income (loss) per share
    
    
    30,758,689
    
    
    
    25,618,296
    
    
    
    23,618,169
    
    
    
    22,484,905
    
    
    
    21,468,763
 Consolidated Balance Sheet Data  December 31, 2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Working capital (deficit)
    
    $
    7,180,382
    
    
    $
    2,427,166
    
    
    $
    (780,117
    )
    
    $
    7,843,465
    
    
    $
    21,543,381Total assets
    
    
    17,426,098
    
    
    
    13,493,183
    
    
    
    15,121,660
    
    
    
    26,618,625
    
    
    
    34,191,574Short-term debt
    
    
    145,019
    
    
    
    2,395,445
    
    
    
    1,556,405
    
    
    
    3,007,152
    
    
    
    1,291,178Long-term liabilities
    
    
    465,492
    
    
    
    449,873
    
    
    
    1,708,804
    
    
    
    1,419,632
    
    
    
    339,908Redeemable preferred stock
    
    
    8,087,274
    
    
    
    2,217,150
    
    
    
    
    
    
    
    
    
    
    
    Stockholders equity
    
    
    5,101,925
    
    
    
    5,277,800
    
    
    
    3,677,994
    
    
    
    14,299,655
    
    
    
    28,444,669
 15




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##### Table of Contents



Item 7.MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview JMAR Technologies, Inc. is a leading innovator in the development of laser-based equipment for
imaging, analysis and fabrication at the nano-scale. The Company is leveraging over a decade of
laser and photonics research to develop a diverse portfolio of products with commercial
applications in rapidly growing industries while continuing to carry out research and development
for the U.S. Defense Advanced Research Projects Agency (DARPA) and support for the U.S.
Governments Defense Microelectronics Activity (DMEA) semiconductor fabrication facility. JMAR is
targeting the nanotechnology, bioscience and semiconductor industries with its
BritelightTM Laser; X-ray Light Source; Compact X-ray Microscope  for 3D visualization
of single cells and polymers; and its X-ray Nano Probe  enabling interaction, analysis and
materials modification at the nano-scale. JMAR also develops, manufactures and markets its
BioSentryTM microorganism early warning system and maintains a strategic alliance for
the production of the READ chemical sensor for homeland security, environmental and utility
infrastructure industries. Sources of Revenue Currently, over 92 percent of the Companys revenues are derived as the prime contractor or
subcontractor for government contracts. These contracts have generated intellectual property owned
by the Company (with limited residual rights held by the government) in areas in which the Company
believes there are significant commercial applications. The most significant ongoing contract has been the contract issued to JMARs Research Division
by the U.S. Army Research Laboratory sponsored by DARPA for further development of the Companys
CPL system (DARPA Contract). A total of $23.7 million has been funded under this contract,
including $3.5 million funded in February 2005. No program funding related to the DARPA Contract is
included in the United States Governments fiscal year 2005 budget and the Company expects no
further funding under this contract. JMARs next most significant contract is a $10 million contract issued to JMARs Vermont
Operations by Naval Air Warfare Center AD to procure sub-100 nm feature size X-ray masks used in
the development and production of high performance GaAs MMICs, and to produce zone plate optics
(NAVAIR Contract). Through December 31, 2004, a total of $8.8 million has been received under this
contract. The Company expects to receive the remaining funding of the Navair Contract and a new
contract to further the work in 2005. The third major ongoing revenue source involves the subcontract between JMARs
Microelectronics Division and General Dynamics Advanced Information Systems (GDAIS) to enhance and
maintain the semiconductor wafer fabrication processes installed at the McClellan Air Force Base in
Sacramento for the DMEA (GDAIS Contract). This work, which started in 1998, has resulted in a new
subcontract each year out of funds available in the DMEAs budget as an element of the Department
of Defenses Advanced Technology Support Program. The Company received $5 million and $3.5 million
in contracts in 2003 and 2004, respectively, for this program and expects further funding in 2005. Unrelated to JMARs Britelight and X-ray source technology, we are preparing to enter the
drinking water, food and beverage and homeland security markets with our new BioSentryTM
sensor product. The BioSentry sensor provides continuous monitoring of drinking water for
microorganisms. This product has successfully passed proof of concept testing and we have assembled
Beta units for installation at various Beta sites in the first and second quarters of 2005. In
early March 2005, we entered into a Technology Testing and Contingent Purchase Agreement with
Olivenhain Municipal Water District (OMWD) which provides for the installation and testing of three
Beta models of the BioSentry sensor at OMWDs water treatment plant in San Diego County. If the
BioSentry Beta units satisfy certain test criteria 16




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##### Table of Contents



during a six month test period, including approval by the state regulator, OMWD has agreed to
purchase three production units. We installed the first Beta test units at OMWD shortly before the
end of the first quarter of 2005. Through our collaboration with FemtoTrace, Inc., we are also involved in the market for
chemical sensors. JMAR has designed, manufactured, and integrated two Alpha versions of the READ
sensor, a highly sensitive chemical detection system under contract for FemtoTrace. JMAR expects
to manufacture a number of Beta units for FemtoTrace in 2005 and is discussing the terms of an
agreement to act as contract manufacturer for the production units of FemtoTraces READ sensor
product line. Opportunities, Challenges and Risks In 2004, we conducted several iron man tests of the Beta version of our X-ray lithography
light source and stepper system to demonstrate the performance of our CPL technology in an effort
to convince the semiconductor industry of the value of CPL technology for semiconductor
fabrication. While we believe that JMARs CPL technology may show its value to the Gallium
Arsenide semiconductor industry in the future, JMAR faces a number of challenges and risks
involving the CPL technology, product design, manufacturing cost, infrastructure readiness,
industry momentum, financing, and competition from substitute lithography technologies. The
continuation of this work is dependent on continued funding by our DARPA contract, as well as
financing and other support provided by one or more strategic partners. No program funding related
to CPL was included in the United States Governments fiscal year 2005 budget, and the Company
expects no further government funding for this work. To date, JMAR has been unable to find any
strategic partners to support commercialization of its CPL technology. With the future prospects of its CPL product development program uncertain and with the
benefit of a substantial investment in intellectual property related to soft X-ray generation, in
2004 JMAR implemented a new strategy to balance, diversify and expand its revenue base through new
product development and technology acquisition. We are now complementing our progress in product
development and market validation with preparation for manufacturing and distribution. In pursuit
of this new strategy, JMAR has identified other, more immediate, commercial opportunities for our
laser and X-ray technology, namely Compact X-ray Microscope and X-ray Nano Probe products. JMAR has
also acquired new technology in multi-angle light scattering and is developing BioSentry products
we can deliver in 2005 to several high growth-rate industries. JMAR intends to continue to pursue
government funding in areas that create valuable technology to support its new product development
efforts. The XRM, XNP and BioSentry development activities are described in more detail in
BusinessProducts and Services above. As JMAR seeks to add commercial revenues to our predominately government contract revenue
base, we face a series of challenges, including technical and market risks and uncertainties
associated with the development of new technologies and new products. Our product development
efforts will require substantial continued investment by JMAR and we expect to face challenges in
transitioning each of our new products from the proof of concept, alpha and beta stages to
commercial introduction and market acceptance. See Factors That May Affect Future Results below
for more information on the risks and uncertainties faced by JMAR. Results of Operations Year Ended December 31, 2004 Compared to Year Ended December 31, 2003 Revenues.Total revenues for the years ended December 31, 2004 and 2003 were $10,059,839 and
$17,296,508, respectively, the majority of which were contract revenues. Revenues by segment for
2004 and 2003 were as follows: 17




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##### Table of Contents



2004
    
    
    2003Research Division
    
    $
    3,575,633
    
    
    $
    6,206,123Vermont Operations
    
    
    2,785,929
    
    
    
    6,561,372Microelectronics Division
    
    
    3,698,277
    
    
    
    4,529,013Sensor Products Group
    
    
    
    
    
    
    $
    10,059,839
    
    
    $
    17,296,508
 The decrease in revenues for the year ended December 31, 2004 compared to the year ended
December 31, 2003 was primarily attributable to a decrease of $2,166,775 in the NAVAIR Contract
revenues at the Vermont Operations due to the delay in receipt of funding on that contract, a
decrease of $3,608,489 in revenues of the Research Division and Vermont Operations related to the
DARPA Contract, a decrease of $1,027,533 related to two contracts at the Vermont Operations that
have been completed and a decrease of $619,994 in contract revenues at the Microelectronics
Division related to reduced equipment installations under the GDAIS Contract in 2004. The lower
revenues for the DARPA contract in 2004 is primarily related to lower funding in 2004 and 2003
compared to 2002, resulting in a lower DARPA Contract backlog entering 2004 compared to fiscal year
2003, exacerbated by the fact that no additional program funding related to the
DARPA Contract was included in
the U.S. Government fiscal year 2005 budget and no further funding under this
contract is expected beyond the funds received in February 2005. Revenues for the three months ended December 31,
2004 and 2003 were $1,755,289 and $3,570,210, respectively. Despite the lower revenues for the
three months ended December 31, 2004 compared to the corresponding period in 2003, receivables at
December 31, 2004 were $3,090,922 compared to $2,802,025 at December 31, 2003. The higher then
expected receivables at December 31, 2004 is due to 1) the continued delay in receipt of funding
for the DARPA Contract ($3.5 million was received in
February 2005); 2) the timing of billings for the
NAVAIR Contract in 2004 compared to 2003 and because of advanced billings allowed under the NAVAIR
Contract in 2004 (resulting in billings in excess of costs incurred at December 31, 2004); and 3)
the timing of billings at the Microelectronics Division. Because of the receipt of the $3.5 million
of DARPA funding in February 2005, the Company expects the
higher than normal accounts
receivable in relation to revenues to normalize starting in the quarter ended June 30, 2005. The Company will
continue to experience flat revenues for 2005 until sales from our new products are realized. Losses. The net loss for the years ended December 31, 2004 and 2003 was $(5,632,140) and
$(3,278,463), respectively. The loss from continuing operations for those same periods was
$(5,417,247) and $(2,086,714), respectively, while the loss from operations for those same periods
was $(4,753,805) and $(1,418,624), respectively. Included in the net loss for the years ended
December 31, 2004 and 2003 is a loss from discontinued operations of $214,893 and $1,191,749,
respectively. Included in the net loss and loss from operations for the years ended December 31,
2004 and 2003 are costs associated with product development (see further discussion below) of
$1,722,329 and $529,039, respectively, and asset write-downs of $191,575 and $346,060,
respectively. Included in the net loss and loss from continuing operations for the years ended
December 31, 2004 and 2003 is a non-cash interest charge of $442,029 and $289,063, respectively
(see Interest and Other Expenses below). Gross Margins. Gross margins for the fiscal years ended December 31, 2004 and 2003 were 19.9%
and 22.9%, respectively. The Companys margins are low because the majority of its revenues are
from contract revenues, which inherently generate lower margins than product revenues. The primary
decrease in the gross margin for the year ended December 31, 2004 compared to the prior year is due
to a contract reserve of $316,000 for the year ended December 31, 2004 related to a contract at the
Vermont Operations and inventory reserves of approximately $168,000 for the year ended December 31,
2004, also at the Vermont Operations. These reductions were offset in part by lower revenues in
2004 on the lower margin NAVAIR Contract (i.e., the lower margin NAVAIR Contract
represented a greater percentage of revenues in 2003). The low margins on the NAVAIR Contract
were due to the high subcontract component of that contract and the Companys absorption of some of
the costs incurred due to limited funding on that contract. The majority of the Companys revenues
for 2005 will be derived from contracts, 18




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##### Table of Contents



so gross margins are expected to continue at similar levels increased somewhat by higher gross
margins expected later in 2005 from sales of BioSentry products. The Company is investing in new
product development activities that it believes will lead to higher margin products in the future. Selling, General and Administrative (SG&A).SG&A expenses for the fiscal years ended December
31, 2004 and 2003 were $4,838,641 and $4,508,152, respectively. The increase in SG&A expenses for
2004 was primarily attributable to 1) SG&A costs of the Sensor Products Group formed in 2004 of
$415,708; 2) higher accounting and insurance costs of $219,332; and 3) higher payroll related costs
of $269,159. These increases were offset in part by a reduction in SG&A costs of the Vermont
Operations due to staff and other cost reductions of $598,585. Research, Development and Engineering Program (RD&E).The Companys RD&E consists of two
types: customer-funded RD&E (U.S. government and other companies) and company-funded RD&E. Both
types of RD&E costs are expensed when incurred.  
    Customer-funded RD&E costs incurred, primarily related to the DARPA Contract and the
NAVAIR Contract, are included in Costs of Revenues and totaled $3,993,862 and
$9,606,745 for the fiscal years ended December 31, 2004 and 2003, respectively. The
decrease in customer-funded RD&E expenditures for 2004 consists of a decrease of
$2,502,495 related to the NAVAIR Contract, a decrease of $2,398,252 related to the
DARPA Contract and decreases in two contracts completed in 2004 at the Vermont
Operations of $712,136.
    Company-funded RD&E costs associated with product development are shown in
Operating Expenses and totaled $1,722,329 and $529,039 for the fiscal years ended
December 31, 2004 and 2003, respectively. The increase in 2004 is due to product
development started in 2004 for our BioSentry, XRM and XNP new products. Total
RD&E expenditures for 2004 and 2003 were $5,716,191 and $10,135,784, respectively.
Total RD&E expenditures as a percentage of revenues were 56.8% and 58.6% for the years ended
December 31, 2004 and 2003, respectively. The RD&E expenditures as a percentage of revenues have
been historically higher than that for a commercially oriented company because much of the
Companys revenues has been R&D contract revenues. During 2004, JMAR has been implementing its strategy to balance, diversify and expand its
revenue base through new product development and to acquire or license products, technologies or
businesses. Specifically, during the second quarter of 2004 the Company started product development
on the BioSentry product line, and during the third quarter of 2004, the Company initiated the
product development of the X-ray Microscope and X-ray Nano Probe product lines. Accordingly, the
Company expects company-funded RD&E to increase significantly for 2005. Discontinued Operations.The loss from discontinued operations of $214,893 for the year ended
December 31, 2004 is related to the standard semiconductor products business, primarily associated
with the lease of the Irvine facility. The loss from discontinued operations of $1,396,749 for the
year ended December 31, 2003 includes $457,413 related to the standard semiconductor products
business, primarily associated with the lease of the Irvine facility and legal costs for disputed
liabilities of that business offset in part by gains from settlement of certain liabilities. In
addition, for 2003, the loss from discontinued operations includes
$939,336 related to JMAR Precision Systems, Inc. (JPSI). In July 2003, the Company sold JPSI to
several private investors. The results of operations of JPSI for 2003
through the sale date are reported in discontinued operations in 2003. The decrease in the loss
from discontinued operations is due to the sale of JPSI in July 2003. The gain on disposal of
discontinued operations of $205,000 for the year ended December 31, 2003 relates to the sale of
JPSI. 19




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##### Table of Contents



Prior to December 31, 2001, as the level of business expected from its standard semiconductor
products business did not materialize, the Company decided to take action to sublease its Irvine
facility and move the standard semiconductor products business into a smaller facility and recorded
a reserve against the Irvine facility lease. The lease provides for rent and related expenses of
approximately $36,000 per month through August 2005. In June 2004, the Company subleased the
facility, however, the sub-tenant defaulted on the sublease in January 2005 and the facility is
currently unoccupied. The Company expects that facility to remain unoccupied until the lease
expires in August, 2005. Interest and Other Expense.Interest and other expense for the year ended December 31, 2004
and 2003 was $821,586 and $731,315. Interest and other expense is higher for 2004 versus 2003
primarily due to the financing transactions the Company entered into in late March 2003 and January
2004 (see Consolidated Liquidity and Financial Condition below). Included in interest expense for
the years ended December 31, 2004 and 2003 is $442,029 and $289,063, respectively, related to the
beneficial conversion feature and fair value of warrants issued in connection with the Working
Capital Line described below. These amounts were charged to expense using the effective yield
method over the period from the issuance date to the earlier of the maturity date of the debt or
the conversion dates. Interest expense for the years ended December 31, 2004 and 2003 also includes
$180,126 and $171,358, respectively, related to the discounted liability for deferred compensation. Preferred Stock Dividends.Included in the loss applicable to common stock in the Statement of
Operations for the year ended December 31, 2004 and 2003 are preferred stock dividends of
$2,247,876 and $942,903, respectively. The amounts for the years ended December 31, 2004 and 2003
represents $341,372 and $78,581, respectively, of preferred stock dividends paid or payable in cash
and $1,906,504 and $864,322, respectively, related to the discount representing the beneficial
conversion feature of the redeemable convertible preferred stock and the fair value of warrants
issued in connection with the preferred stock. Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 Revenues.Total revenues for the years ended December 31, 2003 and 2002 were $17,296,508 and
$18,383,810, respectively, the majority of which were contract revenues. Revenues by segment for
2003 and 2002 were as follows: 2003
    
    
    2002Research Division
    
    $
    6,206,123
    
    
    $
    6,951,114Vermont Operations
    
    
    6,561,372
    
    
    
    7,602,336Microelectronics Division
    
    
    4,529,013
    
    
    
    3,830,360Sensor Products Group
    
    
    
    
    
    
    $
    17,296,508
    
    
    $
    18,383,810
 The decrease in revenues for the year ended December 31, 2003 compared to the year ended
December 31, 2002 was primarily attributable to a decrease of $2,477,779 in revenues of the
Research Division and Vermont Operations related to the DARPA Contract. In 2002, the Company
received higher funding than in 2003 because of the receipt of the initial contract award in
September 2002. This decrease was offset in part by an increase of $751,732 in contract revenues at
the Microelectronics Division related to the receipt of approximately $5 million in contracts from
GDAIS in February 2003. For the year ended December 31, 2003 compared to the year ended December
31, 2002, there was also an increase in the NAVAIR Contract revenues of $984,522 at the Vermont
Operations. Losses.The net loss for the years ended December 31, 2003 and 2002 was $(3,278,463) and
$(11,500,693), respectively. The loss from continuing operations for those same periods was
$(2,086,714) and $(2,461,326), respectively, while the loss from operations for those same periods
was $(1,418,624) 20




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##### Table of Contents



and $(3,109,854), respectively. Included in the net loss for the years ended December
31, 2003 and 2002 is a loss from operations of discontinued operations (see below) of $(1,396,749)
and $(5,839,367), respectively, and a gain (loss) on disposal of discontinued operations for the
years ending December 31, 2003 and 2002 of $205,000 and $(3,200,000), respectively. Included in the
net loss and loss from operations for the year ended December 31, 2003 are asset writedowns of
$346,060. Included in the net loss and loss from operations for the year ended December 31, 2002 is
$1,074,324 for charges recorded related to the retirement benefits associated with the retirement in August 2002 of the Companys
former Chairman and Chief Executive Officer. Also, included in the
net loss and loss from continuing
operations for the year ended December 31, 2002 is a gain on the sale of marketable securities of
$1,349,721. Included in the net loss and loss from continuing operations for the year ended
December 31, 2002 is a deferred income tax expense of $484,423 resulting from an increase in the
valuation allowance against the Companys deferred tax assets. Gross Margins.Gross margins for the fiscal years ended December 31, 2003 and 2002 were 22.9%
and 18.6%, respectively. The Companys margins are low because the majority of its revenues are
from government contracts or subcontracts, which inherently generate lower margins than product
revenues. The increase in the gross margin in 2003 compared to the prior year was primarily due to
higher gross margins on the DARPA contract (33.7% and 26.5% in 2003 and 2002, respectively) due in
part to a higher utilization of direct labor, a $245,000 reserve recorded in 2002 for a contract at
the Vermont Operations related to estimated cost overruns on that contract and higher gross margins
on the Microelectronics Division contract with GDAIS (19.9% and 17.1% in 2003 and 2002,
respectively) due to lower material costs in 2003 offset in part by a contract cost overrun of
$70,000 in 2003. Selling, General and Administrative (SG&A).SG&A expenses for the fiscal years ended December
31, 2003 and 2002 were $4,508,152 and $4,594,716, respectively. Decreases in SG&A expenses in 2003
at the Vermont Operations of $260,284 primarily due to staff and other cost reductions were offset
in part by higher ASIC marketing costs of approximately $119,000 and ISO 9000 costs of
approximately $64,000 incurred by the Microelectronics Division. Research, Development and Engineering Program (RD&E).The Companys RD&E consists of two
types: customer-funded RD&E (U.S. government and other companies) and company-funded RD&E. Both
types of RD&E costs are expensed when incurred.  
    Customer-funded RD&E costs incurred, included in Contract Costs of Sales, totaled
$9,606,745 and $11,528,915 for the fiscal years ended December 31, 2003 and 2002,
respectively. The decrease in customer-funded RD&E expenditures for 2003 is related to
a decrease in contract costs of $2,369,387 incurred related to the DARPA contract and
decreases in two contracts at the Vermont Operations of $399,972 offset in part by an
increase in contract costs of $847,189 related to the NAVAIR Contract.
    Company-funded RD&E costs are included in Operating Expenses and totaled $529,039
and $854,306 for the fiscal years ended December 31, 2003 and 2002, respectively. Total
RD&E expenditures for 2003 and 2002 were $10,135,784 and $12,383,221, respectively.
Total RD&E expenditures as a percentage of sales were 58.6% and 67.4% for the years ended December
31, 2003 and 2002, respectively. These expenditures were primarily related to the continued
development of CPL systems for the semiconductor industry and the continued development of a high
efficiency EUV generation system for advanced semiconductor lithography. Discontinued Operations.The loss from operations of discontinued operations of $1,396,749 for
the year ended December 31, 2003 consists of $457,413 related to the standard semiconductor
products business primarily associated with the lease of the Irvine facility and legal costs for
disputed liabilities of that business offset in part by gains from settlement of certain
liabilities. In addition, for 2003, the loss from discontinued operations includes $939,336 related
to JPSI. The loss from operations of discontinued operations of
$5,839,367 for the year ended December 31, 2002 consists of 21




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##### Table of Contents



$1,856,381 related to the standard
semiconductor products business and $3,982,986 related to JPSI,
including a facility reserve of $206,000. The decrease in the loss of operations of discontinued
operations is primarily due to the shutdown of the operations of the semiconductor products
business in 2002 and the sale of JPSI in July 2003. We were not able to find a buyer for the
standard semiconductor products business, accordingly, we shut that business down in mid-2002.
There was no loss on disposal because all assets had previously been written off. The gain (loss)
on disposal of discontinued operations of $205,000 and $(3,200,000) for the years ended December
31, 2003 and 2002, respectively, relates to the sale of JPSI. The loss on disposal of discontinued
operations of $3,200,000 for the year ended December 31, 2002 includes a write-down of inventory of
$2,502,989, a write-down of goodwill and other intangible assets of $370,485 and a write-down of
fixed assets of $326,526. Gain on Sale of Marketable Securities.The gain on sale of marketable securities of $1,349,721
for 2002 is related to the sale of 545,500 shares of the Companys investment in Bede plc in
January 2002. Interest and Other Expense.Interest and other expense for the years ended December 31, 2003
and 2002 was $731,315 and $284,174, respectively. Interest and other expense is higher for 2003
versus 2002 primarily due to the financing transactions the Company entered into in 2003 (see
Consolidated Liquidity and Financial Condition below). Included in interest expense for the year
ended December 31, 2003 is $289,063 related to the beneficial conversion feature associated with
the securities issued in these financing transactions. Interest expense for the years ended
December 31, 2003 and 2002 also includes $171,358 and $48,159, respectively, related to the
discounted liability for deferred compensation associated with the retirement in August 2002 of the
Companys former Chairman and Chief Executive Officer. Preferred Stock Dividends.Included in the loss applicable to common stock in the Statement of
Operations for the year ended December 31, 2003 are preferred stock dividends of $942,903. This
amount represents $78,581 of preferred stock dividends paid or
payable in cash and $864,322 related
to the discount representing the beneficial conversion feature of the redeemable convertible
preferred stock and the fair value of warrants issued in connection with the preferred stock. Liquidity and Financial Condition General.Cash and cash equivalents at December 31, 2004 was $6,599,588. In 2004 and 2003, we
have funded our operations primarily from the sale of preferred stock. The increase in cash and
cash equivalents during the year ended December 31, 2004 of $2,428,409 resulted primarily from net
proceeds from the issuance of preferred stock of $9,070,870 offset by cash used in continuing
operations operating activities of $3,763,107 (primarily related to operating losses), payments of notes payable of
$868,642, cash used in discontinued operations of $778,927, preferred stock redemptions of
$416,667, capital expenditures of $408,038 and payment of preferred stock dividends of $249,760. JMAR will continue to use cash in 2005 for 1) product research and development efforts and to
acquire or license products, technologies or businesses; 2) corporate costs, primarily related to
the cost of being a public company; 3) preferred stock dividends; and 4) other working capital
needs. As a result of the financing activity discussed below, management believes that the Company
has adequate resources to fund working capital requirements and product development at least
through December 31, 2005. Working capital as of December 31, 2004 and 2003 was $7,180,382 and
$2,427,166, respectively. The increase in working capital is primarily due to gross proceeds from
the issuance of preferred stock of $9.5 million and the conversion into common stock of $1,254,500
of the Companys line of credit, offset in part by the Companys losses. Issuances of Preferred Stock. In 2004 and 2003, the Company sold the following series of
Preferred Stock to Laurus for cash: 22




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##### Table of Contents



Converted in 2003
    
    
    Converted in 2004OriginalConversion
    
    
    
    
    
    
    Shares
    
    
    
    
    
    
    SharesIssuance Date
    
    Series
    
    Amount
    
    
    Dividend
    
    Price
    
    
    Amount
    
    
    Issued
    
    
    Amount
    
    
    IssuedMarch, 2003
    
    A
    
    $
    1,000,000
    
    
    8%
    
    $
    0.88
    
    
    $
    1,000,000
    
    
    
    1,136,363
    
    
    
    
    
    
    
    March, 2003
    
    B
    
    $
    1,000,000
    
    
    3%
    
    $
    0.88
    
    
    $
    1,000,000
    
    
    
    1,136,364
    
    
    
    
    
    
    
    September, 2003
    
    C
    
    $
    1,500,000
    
    
    8%
    
    $
    2.08
    
    
    
    
    
    
    
    
    
    
    $
    1,500,000
    
    
    
    721,154December, 2003
    
    D
    
    $
    2,000,000
    
    
    8%
    
    $
    1.56
    
    
    
    
    
    
    
    
    
    
    $
    2,000,000
    
    
    
    1,282,051January, 2004
    
    E
    
    $
    1,500,000
    
    
    8%
    
    $
    2.85
    (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February, 2004
    
    F
    
    $
    2,000,000
    
    
    Prime
    (2)
    $
    3.11
    (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February, 2004
    
    G
    
    $
    2,000,000
    
    
    Prime
    (2)
    $
    3.28
    (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February, 2004
    
    H
    
    $
    4,000,000
    
    
    Prime
    (2)
    $
    3.47
    (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 (1)
  
  Reduced to $2.00 pursuant to February 1, 2005
agreement (see below)(2)
  
  Prime rate at December 31, 2004 was 5.25 percent
 If not previously converted to common stock, the outstanding amount of Series E, F, G and
H Preferred Stock must be redeemed in cash (or it could be redeemed with common stock if the
closing market price of the Companys common stock is 118% of the Conversion Price or higher for
the 11 trading days prior to the redemption date) at various amounts and dates (see below under
Commitments). Conversions to equity are offset against the required repayments. Except for the
conversion price, the conversion terms of the Series E through H Preferred Stock are the same as
the conversion terms of the Working Capital Line (see below). On February 1, 2005, the Company entered into agreements with Laurus to amend the Companys
Series E, F, G and H Convertible Preferred Stock (the Amendments). The Amendments provide for 1)
the deferral of approximately $3.8 million in monthly redemption payments, as follows: a) payments
of the remaining 12 months of redemption payments ($83,333 per month) for the Series E Preferred
Stock are deferred until July, 2006, and b) the next 18 months of redemption payments due under the
Series F, G and H Convertible Preferred Stock ($150,000 per month) are deferred until February,
2007; 2) the grant of a right to the Company to elect to pay the originally scheduled monthly
redemption payments with shares of the Companys Common Stock valued at a 15% discount to the then
market price; and 3) the reduction in the conversion prices of the Series E-H Preferred Stock
(originally ranging from $2.85 to $3.47) to $2.00 per share. The monthly redemption payments under
the Series F-H Preferred Stock will recommence in August, 2006 until January, 2007, with the
balance of approximately $4.25 million in the stated amount of the Series F-H Preferred Stock due
in February, 2007. These redemption payments will be reduced to the extent that there are
conversions of the Preferred Stock into Common Stock. In connection with all of the above financing transactions with Laurus (Working Capital Line
and Series A-H Preferred Stock Issuances), the Company issued warrants to Laurus to purchase a
total of 1,390,000 shares of common stock at prices ranging from $1.058 to $5.15. In addition,
Laurus was granted the right to receive a warrant to purchase one share of common stock at $3.13
for every $20 of principal of the Working Capital Line
that is converted to equity up to a total of 50,000 shares. The shares of common stock issuable to Laurus under all of the preferred stock and warrants
described above have been included in registration statements declared effective by the Securities
and Exchange Commission. Working Capital Line. In March 2003, the Company entered into a Revolving Fixed Price
Convertible Note (Working Capital Line) with Laurus. As of December 31, 2004, there was no amount
outstanding under the Working Capital Line. The Working Capital Line allows the Company to borrow
from time-to-time up to 85% of eligible accounts receivable of the Company
to a maximum of $3 million. Advances in excess of this formula are allowed, however, with the
consent of Laurus. Laurus can convert any portion of the principal outstanding to common stock at a
fixed price per share (Conversion Price) any time the market price of the Companys common stock is
in excess of the Conversion Price. The Company can convert a portion of the principal outstanding
to common stock at the Conversion Price if 23




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##### Table of Contents



the market price of the Companys common stock averages
118% of the Conversion Price or higher for 22 consecutive trading days. The initial terms of the
Working Capital Line provided that after $2 million of conversions into equity, the Conversion
Price would be increased. The Conversion Price initially was $.92, but was increased to $2.85 in
January 2004 after $2 million of the Working Capital Line had been converted. The interest rate on the Working Capital Line is equal to the prime rate (5.25% at December
31, 2004) plus 0.75 percent, subject to a floor of 5.00 percent. Accrued interest is payable
monthly. The Working Capital Line requires that the Companys quick ratio, as defined, be 0.90 or
higher. The quick ratio is defined as the sum of cash and accounts receivable divided by the sum of
current liabilities, exclusive of current liabilities of discontinued operations. The Companys
quick ratio was 2.87 at December 31, 2004. The term of the Working Capital Line runs until March,
2006. The available borrowings under the Working Capital Line were approximately $2.6 million at
December 31, 2004, all of which was unused at December 31, 2004. Cash Used in Continuing Operations. Cash used in continuing operations was $3,763,107 in 2004
compared to $3,579,238 in 2003. The loss from continuing operations
net of non-cash items (depreciation, amortization, debt discount,
services received in exchange for common stock or warrants, and patent
and equipment write-downs) was
$4,070,018 and $759,314 in 2004 and 2003, respectively. The higher use of cash in continuing
operations in 2004 is primarily due to lower revenues resulting in a lower gross profit in 2004
compared to 2003 of $1,965,887 and higher product development costs in 2004 compared to 2003 of
$1,193,290. The Company expects revenues to continue at the levels experienced in 2004 until its
commercial products enter the marketplace later in 2005. In addition, product development
expenditures will increase in 2005 as the Companys product development activities accelerate.
Helping cash flow from operations in 2004 was an increase in billings in advance of incurring
related costs of $791,587 related to several of the Companys contracts and orders, primarily the
NAVAIR Contract related to milestones achieved in December 2004. Customer deposits decreased by
$832,607 in 2003 related to a large deposit the Company received on one of its contracts in 2001.
This contract was completed in 2004 and the Company expects no further customer deposits of that
magnitude. Accounts payable and accrued liabilities decreased by
$1,175,069 in 2003 primarily because of the Companys better liquidity position as a
result of the financings in March 2003 and because of costs incurred in
2003 on one of the Companys contracts for which a reserve was
established in 2002. The decrease in billings in excess of costs
incurred in 2002 of $853,698 was due to milestone billings in 2002 allowed
pursuant to two contracts. Cash Used in Discontinued Operations. In 2004, cash used in discontinued operations was
$778,927 compared to $2,016,481 in 2003. Cash used in 2004 included losses of $200,568, payments
related to the Irvine facility of $354,754, payment of $137,500 to a creditor of the discontinued
standard chip business, payments of $73,340 for a note payable related to assets financed by the
discontinued standard chip business and legal payments of $12,765. The 2003 cash used included
non-cash losses of $944,568, payments of $429,594 related to the Irvine facility, payment of
$500,000 to a creditor of the discontinued standard chip business, $76,203 in note payments, legal
payments of $59,175 and other payments of $6,941. The Company expects cash required for
discontinued operations to decline in 2005 to approximately $300,000, primarily related to the
payment of the remaining lease payments for the Irvine facility. Cash Used in Investing Activities. In 2004, cash used in investing activities, primarily
capital expenditures and patent costs, was $704,885 compared to $395,697 in 2003. The Company
expects an increase in capital expenditures in 2005 primarily related to the ramp-up of
manufacturing at the Vermont Operations and consolidation and expansion of its three San Diego
facilities into one location. Cash Provided by Financing Activities. In 2004, cash provided by financing activities was
$7,675,328 compared to $7,916,331 in 2003. Net proceeds from the sale of preferred stock were
$9,070,870 in 2004 and $5,202,333 in 2003. In 2004, the Company made note payments of
$868,642, primarily related to the SAL Notes (see Note 8 to Financial Statements) and in 2003
note payments were $285,999. During 2004, the Company made preferred stock redemptions of $416,667
(see preferred stock Amendments discussed above). In 2003, net proceeds from the issuance of common
stock were $1,238,899 and $1,550,000 of restricted cash was released due to the conversion of
preferred stock. 24




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##### Table of Contents



Stockholders Equity. The Companys stockholders equity was $5,101,925 as of December 31,
2004. In May, 2003, the Company transferred to the Nasdaq SmallCap Market, where it is required to
maintain no less than $2.5 million of stockholders equity to retain its listing. Continued losses
without increases in equity would cause the Company to fall below this NASDAQ requirement, which
would require it to come into compliance or face delisting. The delisting of the Companys stock
could adversely affect its ability to raise funds in the future. The Company believes that it has
available to it several potential sources of capital to meet NASDAQ listing standards. Sale of Common Stock in 2005. On February 1, 2005, the Company entered into a Securities
Purchase Agreement and completed the sale of $4 million of the Companys Common Stock and Warrants
to five institutional investors (Investors). Pursuant to the Securities Purchase Agreement, the
Company issued a total of 3,225,807 shares of Common Stock and Warrants to purchase 1,209,679
shares of Common Stock to the Investors. The Warrants have an exercise price of $1.73 per share and
a term of five years. After expenses of the transaction and the advisors fee, the Company received
net proceeds of approximately $3,852,000. Commitments Future minimum annual commitments under contractual obligations, net of sublease income, and
deferred compensation as of December 31, 2004 are as follows (unaudited): 2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    TotalLeases
    
    $
    664,805
    
    
    $
    76,658
    
    
    $
    13,749
    
    
    $
    13,657
    
    
    $
    5,085
    
    
    $
    773,954Deferred compensation
    

    
    282,377
    
    
    
    269,377
    
    
    
    269,377
    
    
    
    184,484
    
    
    
    56,003
    
    
    
    1,061,618$
    947,182
    
    
    $
    346,035
    
    
    $
    283,126
    
    
    $
    198,141
    
    
    $
    61,088
    
    
    $
    1,835,572
 The leases are primarily for office facilities. The deferred compensation is presented at
the total amount to be paid, whereas the liability has been discounted for financial reporting
purposes. Several of the Companys San Diego County facility leases are expiring through April 30,
2006 and the Company expects to enter into a new multi-year lease in the next several months in
connection with the consolidation of its San Diego County operations into a single facility. Preferred Stock Redemption Obligations Excluded from the above table are redemption obligations under Series E, F, G and H Preferred
Stock, as amended on February 1, 2005. Also excluded from the above table is the Companys $3
million Working Capital Line, as to which no amounts were outstanding at December 31, 2004. If not
previously converted, the Series E through H Preferred Stock, as amended, must be redeemed by the
Company as follows: Scheduled RedemptionsGross AmountOutstanding atDescription
    
    December 31, 2004
    
    
    2005
    
    
    2006
    
    
    2007
    
    
    TotalSeries E Preferred
    
    $
    1,083,333
    
    
    $
    83,333
    
    
    $
    1,000,000
    
    
    $
    
    
    
    $
    1,083,333Series F Preferred
    
    $
    2,000,000
    
    
    
    37,500
    
    
    
    187,500
    
    
    
    1,775,000
    
    
    
    2,000,000Series G Preferred
    
    $
    2,000,000
    
    
    
    37,500
    
    
    
    187,500
    
    
    
    1,775,000
    
    
    
    2,000,000Series H Preferred
    
    $
    4,000,000
    
    
    
    75,000
    
    
    
    375,000
    
    
    
    3,550,000
    
    
    
    4,000,000$
    233,333
    
    
    $
    1,750,000
    
    
    $
    7,100,000
    
    
    $
    9,083,333
 25




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##### Table of Contents



Resolution of SAL Earn-Outs Under the Merger Agreement entered into in August, 2001 with the former shareholders and
creditors of SAL, Inc. (now operating as the Companys Vermont Operations), those persons could
have earned up to three contingent earn-out payments upon the satisfaction of certain conditions
related to the development and sale of CPL lithography systems. The first earn-out was not achieved
by the deadline and, therefore, was not earned by the SAL investors. Based on the uncertainties of market acceptance of the CPL technology and delays in the
completion of the CPL system, which operated to delay the achievement of the second and third
earn-outs, on July 9, 2004, the Company sent a letter to former shareholders and creditors
(Holders) of SAL, Inc. proposing a final resolution of the second and third earn-outs through
payment of a total of $625,000 in shares of common stock, valued at the average of the closing
prices of JMARs common stock for the five trading days during the period August 18, 2004 to August
24, 2004. Holders of more than 99 percent of the earn-out interests accepted the Companys offer
to receive the final payment of $625,000 in common stock in full satisfaction of all remaining
amounts owed under the Merger Agreement. LXT Alliance Agreement (BioSentry) During the second quarter of 2004, the Company entered into an alliance agreement with Gregory
Quist and David Drake, dba The LXT Group (LXT) to produce an early-warning system (BioSentry) for
drinking water, food and beverage and homeland security markets. As part of the agreement, JMAR
loaned the two principals of LXT $62,500 each and agreed to provide a maximum financial commitment
of $1 million, subject to the achievement of milestones by LXT. Through December 31, 2004, the
Company had fulfilled this commitment. The alliance agreement also provided for execution of a
purchase agreement (Original Purchase Agreement) after achievement of certain development
milestones. In September 2004, the Company and LXT executed a definitive purchase agreement for
the purchase by the Company of the LXT business. The closing of the sale of the LXT assets to JMAR
was originally scheduled for January 7, 2005, subject to the satisfaction of certain closing
conditions, including the achievement of product development, budget and marketing milestones and
JMARs satisfaction with certain intellectual property matters. Because certain of the closing
conditions were not satisfied as of January 7, 2005, the closing date was extended pending
discussions by LXT and JMAR of the resolution of these closing conditions and the modification to
certain of the terms of the Purchase Agreement. On February 21, 2005, JMAR and LXT executed a Technology Transfer and License Agreement
(License Agreement) that terminated and replaced the Original Purchase Agreement. The License
Agreement provides for the transfer to JMAR of certain trademarks and rights to certain designs and
data related to the BioSentry product, plus the grant of an exclusive, perpetual, worldwide license
by LXT to JMAR to use certain technology covered in pending utility patent application filed by LXT
in January, 2005 with the United States Patent & Trademark Office entitled Continuous On-Line
Real-Time Surveillance System. The scope of this license is limited to the use of light scattering
for detection of microorganism contamination and other particles in water. In consideration for the
transfer of the rights and license of the technology described above, JMAR agreed to pay LXT a
royalty equal to two percent (2%) of the gross revenue of any nature arising from the BioSentry
system used for the detection of microorganisms in water regardless of the technology employed,
commencing on the date JMAR receives the first dollar of BioSentry revenue (Revenue Start Date) and
continuing until the seventh anniversary thereof. The
royalty payments are payable on a quarterly basis within 45 days after the end of each
quarter. The License Agreement also modified the outstanding $125,000 loan to provide that it will
no longer be secured by the LXT assets and to provide that it shall be satisfied solely from
royalty payments generated from revenues received after the third anniversary of the Revenue Start
Date and shall be repaid by payment of 50% of such royalty payments until repaid in full (Amended
Loan). The Amended Loan will accrue interest at the prime rate starting on April 2, 2005 until
satisfied or discharged. In connection with the execution of the License Agreement, JMAR also
entered into a Consulting Agreement for Technical and Other Services for the provision of
consulting services to JMAR by LXT (Consulting Agreement). Pursuant to the Consulting 26




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Agreement,
JMAR agrees to engage LXT to perform at least 1100 hours of consulting services at the rate of $110
per hour until December 31, 2005, with the provision of and payment for a minimum of 50 hours of
agreed-upon services in any month. This consulting obligation supersedes and replaces the prior
agreement under the Original Purchase Agreement to enter into three year employment agreements. Net Operating Loss Carryforward At
December 31, 2004, the Company had approximately $50 million of Federal net operating loss
carryforwards subject to certain annual limitations, which expire from 2005 through 2024. To the
extent the Company has taxable income in the future, these carryforwards may be used by the Company
to reduce its cash outlay for taxes. Critical Accounting Policies and Estimates Managements Discussion and Analysis of Financial Condition and Results of Operations
discusses JMARs consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation of these financial
statements requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses during the reporting
period. On an ongoing basis, management evaluates its estimates and judgments, including those related
to revenues, goodwill and intangible assets, beneficial conversion feature and warrant valuation,
deferred taxes and stock based compensation. Management bases its estimates and judgments on
historical experience and on various other factors that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions. Management believes the
following critical accounting policies, among others, affect its more significant judgments and
estimates used in the preparation of its consolidated financial statements. Revenues For each of the three years ended December 31, 2004, 2003 and 2002, in excess of 95% of the
Companys revenues were contract revenues, with the remainder mostly spare parts sales and service.
Contract revenues are recognized based on the percentage of completion method wherein income is
recognized pro-rata over the life of the contract based on the ratio of total incurred costs to
anticipated total costs of the contract. The program manager prepares a statement of work, schedule
and budget for each contract. At least quarterly, actual costs are compared to budget and technical
progress is compared to the planned schedule. The Company prepares an estimate of costs to complete
for each contract at least quarterly. Estimated losses based on this review are fully charged to
operations when identified. Actual costs could differ from these estimated costs. Reimbursable or
recoverable general and administrative (G&A) costs are charged to G&A expense as incurred. Goodwill and Intangible Assets In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, effective January 1,
2002, the Company has established reporting units and applies a two-step fair value approach to
evaluating goodwill impairment, using at least an annual assessment. The Company compares the fair
value of the business unit with the carrying amount of the assets associated with the business
unit. The fair value of each business unit is determined using a risk adjusted discount rate to
compute a net present value of estimated future cash flows and a consideration of market
capitalization of the Company. The second step measures the amount of the impairment, if any. 27




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Management performed an interim evaluation of goodwill as of June 30, 2004
following notification that no additional funding was included in the
Governments fiscal year 2005 budget. A further evaluation of
goodwill was performed again as of December 31, 2004. The business units currently
identified are Vermont Operations/Research Division, Microelectronics Division and Sensor Products
Group. All of the Companys goodwill arose from the acquisition of SAL, Inc. (the predecessor to
the Vermont Operations) and is allocated to the Vermont Operations/Research Division business unit.
The Research Division and Vermont Operations are viewed as one business unit due to the
interrelations of their businesses (i.e., X-ray source related commercialization, including the XRM
and XNP products, with the source and technology development coming from the Research Division and
the product design, manufacturing engineering, integration, testing and manufacturing performed by
the Vermont Operation, as well as the zone plate optics development and manufacturing for the XRM
and XNP performed by the Vermont Operations). Additionally, the Vermont Operations will use its
core capabilities to perform manufacturing for other products of the Company, as well as performing
contract manufacturing for other companies products. The discounted cash flow analysis is based on a 7-year projection of revenue, operating
expenses, capital expenditures, and working capital requirements and a continuity value of 5 times
the 7th year cash flow. The discount rate used for the most recent analysis is 30%,
taking into account the riskiness of the new products. Sensitivity analysis is also performed to
determine the appropriateness of the assumptions used in the discounted cash flow analysis. As a
majority of the Companys expected revenues in the future are based on products that are currently
under development, the Company estimates the expected revenues based on its current knowledge of
the market and our expectations of successfully penetrating those markets. If our future cash flows
vary significantly from our assumptions we may record an impairment of goodwill. The market capitalization test is used as a complementary test to the discounted cash flow
analysis. The Company estimates its market capitalization based on the average stock price over the
preceding year and estimates the three business units relative contribution to the market value of
the Company based on shareholder inquiries, emphasis by the Company in discussions with
shareholders and others, and emphasis in formal shareholder communications (i.e., press releases). Capitalized patent costs are amortized over ten years, and other intangible assets are
amortized over not more than five years. Capitalized patent costs are reviewed quarterly for
utilization and recoverability. Beneficial Conversion Feature and Warrant Valuation In accordance with Financial Accounting Standards Board (FASB) Emerging Issues Task Force
Issue (EITF) No. 98-5 and FASB EITF No. 00-27, the Company records a beneficial conversion feature
(BCF) related to the issuance of convertible preferred stock and convertible debt that have
conversion features at fixed rates that are in the money when issued and records the fair value of
warrants issued with those instruments. The BCF for the convertible instruments is recognized and
measured by allocating a portion of the proceeds to warrants and as a
reduction to the carrying amount of the convertible instrument equal to the intrinsic value of the
conversion features both of which are credited to paid-in-capital. The Company calculates the fair
value of warrants issued with the convertible instruments using the Black Scholes valuation method,
using the same assumptions used for valuing employee options for purposes of SFAS #123, except that
the contractual life of the warrant is used. For convertible preferred stock and related warrants, the recorded discount is recognized as a
dividend from the date of issuance to the earlier of the redemption dates or the conversion dates
using the effective yield method. For convertible debt and related warrants, the recorded discount
is recognized as interest expense from the date of issuance to the earlier of the maturity date of
the debt or the conversion dates using the effective yield method. 28




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Deferred Taxes JMAR records a valuation allowance to reduce its deferred tax assets to the amount that
management believes is more likely than not to be realized in the foreseeable future, based on
estimates of foreseeable future taxable income and taking into consideration historical operating
information. In the event management estimates that it will not be able to realize all or part of
its net deferred tax assets in the foreseeable future, a valuation allowance is recorded through a
charge to income in the period such determination is made. Likewise, should management estimate
that it will be able to realize its deferred tax assets in the future in excess of its net recorded
asset, an adjustment to reduce the valuation allowance would increase income in the
period such determination is made. Stock-Based Compensation Plans The Company accounts for its stock option and warrant plans under APB Opinion No. 25, using
the intrinsic value method, under which no compensation cost has been recognized for issuances to
employees. Options and warrants issued to non-employees (other than directors) are accounted for
based on the fair value of the equity instrument issued. The fair value is calculated based on the
Black Scholes pricing model. The resulting value is amortized over the service period. In December
2004, the FASB issued FASB Statement No. 123(R), Share-Based Payment, (SFAS No. 123(R)) which is
a revision of SFAS No. 123 and which supersedes APB Opinion No. 25. SFAS No. 123(R) requires all
share-based payments to employees, including grants of stock options, to be recognized in the
income statement based on their fair values. SFAS No. 123(R) must be adopted no later than July 1,
2005. Factors That May Affect Future Results Certain
statements contained in this Form 10-K which are not related to
historical results are forward-looking statements,
including statements regarding JMARs future sales or profit growth, competitive position or
products, projects or processes currently under development, the ability of the Company to
successfully introduce new products into the commercial marketplace or to apply those products,
projects or processes to alternative applications. These
forward-looking statements are based on certain assumptions and are subject to certain risks and
uncertainties that could cause actual future performance and results to differ materially from
those stated or implied in the forward-looking statements. In addition to the several risks and uncertainties described in the Business Section and in
this Managements Discussion and Analysis of Financial Condition and Results of Operations,
additional risks and uncertainties include the following:  
    delays and unanticipated technological or engineering difficulties in the Companys new
product development efforts, which involve lengthy and capital intensive programs that
are subject to many unforeseen risks, delays, problems and costs and uncertainties as to
the markets demand for such new products;
    the risk that competitors with greater resources enter the markets for the Companys
new products;
    the risk that our portfolio of intellectual property does not contain all of the
intellectual property rights that may be required to develop, manufacture and
commercialize our new products and that we may be unable to license such technologies on
reasonable terms;
    the effect of government regulations and required approvals on the BioSentry and X-ray
products;
    longer than anticipated purchase approval cycles and more extensive selling efforts in
connection with the sale of the Companys new products to utilities and other regulated
customers; 29




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
    the risk that the Company is subject to claims for product liability arising from the
sale of its new products and, specifically with regard to its BioSentry system, that the
Company is unable to obtain adequate product liability insurance to cover these risks at a
reasonable cost, and that the Company is unable to obtain indemnification agreements from
its customers to hold the Company harmless from such claims;
    delays in securing, or inability to secure other financing, whether from the public or
private debt or equity markets or from commercial lenders or otherwise, for working
capital needs or for development of the Companys new products;
    the continued dilution to current shareholders resulting from the sale of additional
equity interests to finance the Companys product development and commercialization
efforts;
    unanticipated difficulties and costs in establishing the Companys Vermont operations
as the manufacturing center for the Companys new products;
    despite substantial technical, marketing and sales efforts and the expenditure of
significant funds by the Company, the failure to convince semiconductor manufacturers to
adopt the Companys CPL technology over other existing and possible future alternative
lithography technologies;
    the lack of availability of critical components from third party suppliers, including
laser diodes, X-ray optics (including zone plates), X-ray masks,
photo-resist and
holographic optical element, or the inability to obtain such components at acceptable
costs;
    fluctuations in margins, or the failure to lower manufacturing costs sufficiently to
achieve acceptable margins;
    the failure of pending patents to be issued and uncertainties as to the breadth or
degree of protection of existing or future patents covering the Companys X-ray, BioSentry
and other technologies and applications; and
    other risks detailed in the Companys Form 8-K, filed March 30, 2005, and in other
filings with the Securities and Exchange Commission. 
 Item 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Companys exposure to interest rate risk is minimal due to the relatively small amount of
investments and variable rate debt. The Company has no investments in derivative financial
instruments. 
 Item 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Companys consolidated financial statements prepared in accordance with Regulation S-X and
Report of Independent Certified Public Accountants are set forth at the end of this Report on pages
34 through 61. 
  Item 9.
    CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ANDFINANCIAL DISCLOSURE Not applicable. 
 Item 9A.CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the Companys Exchange Act reports is recorded, processed, 30




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summarized and reported within the time periods specified in the SECs rules and forms, and that
such information is accumulated and communicated to the Companys management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. In designing and evaluating the disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving the desired control objectives, and management necessarily
was required to apply its judgment in evaluating the cost-benefit relationship of possible controls
and procedures. The Company carried out an evaluation, under the supervision and with the participation of the
Companys management, including the Companys Chief Executive Officer and the Companys Chief
Financial Officer, of the effectiveness as of December 31, 2004 of the design and operation of the
Companys disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)). Based on
such evaluation, the Companys Chief Executive Officer and Chief Financial Officer concluded that
the Companys disclosure controls and procedures were effective. There have been no changes in the Companys internal control over financial reporting during
the quarter ended December 31, 2004 that have materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting. The Company is not an accelerated filer and, therefore, the internal controls certification
and attestation requirements of Section 404 of the Sarbanes-Oxley Act are not applicable to the
Company for the fiscal year ended December 31, 2004. However, starting in the second quarter of
2004, the Company has been reviewing and testing its internal control procedures and it retained an
outside firm to assist in this process. 
 PART III 
 Item 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 is set forth in the 2005 Proxy Statement under the
captions Election of Directors, Executive Officers of the Registrant, The Audit Committee and
Section 16(a) Beneficial Ownership Reporting Compliance and is incorporated herein by reference. The Company has adopted a Code of Business Conduct and Ethics in compliance with the
applicable rules of the Securities and Exchange Commission that applies to all employees, including
all officers, and our non-employee directors, and a Code of Ethics for our Chief Executive Officer,
Division General Managers and all senior financial officers, including the Chief Financial Officer
and principal accounting officer. The Company has filed a copy of these policies as exhibits to the
Form 10-K for the year ended December 31, 2003. In the event we amend or waive any of the
provisions of the Code of Ethics, we intend to disclose the same on the Companys website at
http://www.jmar.com under the caption Corporate Governance  Code of Ethics. 
 Item 11.EXECUTIVE COMPENSATION The information required by Item 11 is set forth in the 2005 Proxy Statement under the caption
Executive Compensation and is incorporated herein by this reference. 
  Item 12.
    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS The information required by Item 12 is set forth in the 2005 Proxy Statement under the
captions Information About JMAR Stock Ownership and Equity Compensation Plan Information and is
incorporated herein by this reference. 31




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Item 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is set forth in the 2005 Proxy Statement under the caption
Certain Transactions with Management and Others and is incorporated herein by this reference. 
 Item 14.PRINCIPAL AUDITOR FEES AND SERVICES The information required by Item 14 is set forth in the 2005 Proxy Statement under the
captions Report of the Audit Committee, Audit Fees, Audit-Related Fees, Tax Fees, All
Other Fees and Audit Committee Pre-Approval Policies and Procedures and is incorporated herein
by this reference. 
 PART IV 
 Item 15.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. Index to Consolidated Financial Statements: Report of Independent Registered Public Accounting Firm
    
    
    34Consolidated Balance Sheets as of December 31, 2004 and 2003
    
    
    35Consolidated Statements of Operations for the Years Ended December 31, 2004, 2003 and 2002
    
    
    36Consolidated Statements of Comprehensive Loss for the Years
Ended December 31, 2004, 2003 and 2002
    
    
    37Consolidated Statements of Stockholders Equity for the Years Ended
December 31, 2004, 2003 and 2002
    
    
    38Consolidated Statements of Cash Flows for the Years Ended December 31,
2004, 2003 and 2002
    
    
    39Notes to Consolidated Financial Statements
    
    
    40
  2.
    Financial Statement Schedule. The following financial statement
schedule of JMAR Technologies, Inc., for the years ended December 31, 2004, 2003 and
2002 is filed as part of this Report and should be read in conjunction with the
Consolidated Financial Statements of JMAR Technologies, Inc.Schedule II. Valuation and Qualifying AccountsFinancial Statement 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 in the accompanying Exhibit Index on
pages 63 to 66 are filed as part of this Form 10-K. (b) Reports on Form 8-K. The Company filed a Report on Form 8-K on November 15, 2004 reporting the announcement of its
financial results for the quarter ended September 30, 2004. 32




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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm
    
    
    34Consolidated Balance Sheets as of December 31, 2004 and 2003
    
    
    35Consolidated Statements of Operations for the Years Ended December 31, 2004,
2003 and 2002
    
    
    36Consolidated Statements of Comprehensive Loss for the Years Ended
December 31, 2004, 2003, and 2002
    
    
    37Consolidated Statements of Stockholders Equity for the Years Ended December 31,
2004, 2003 and 2002
    
    
    38Consolidated Statements of Cash Flows for the Years Ended December 31, 2004,
2003 and 2002
    
    
    39Notes to Consolidated Financial Statements
    
    
    40
 33




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Shareholders
JMAR Technologies, Inc.: We have audited the accompanying consolidated balance sheets of JMAR Technologies, Inc. (a
Delaware corporation) as of December 31, 2004 and 2003, and the related consolidated statements of
operations, comprehensive loss, stockholders equity and cash flows for each of the three years in
the period ended December 31, 2004. These 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 financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of internal control
over financial reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of the
Companys internal control over financial reporting. Accordingly, we express no such opinion. An
audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, 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 consolidated financial position of JMAR Technologies, Inc. as of December 31, 2004
and 2003, and the consolidated results of its operations and its consolidated cash flows for each
of the three years in the period ended December 31, 2004, in conformity with accounting principles
generally accepted in the United States of America. We have also audited Schedule II of JMAR Technologies, Inc. for each of the three years in the
period ended December 31, 2004. In our opinion, this schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly, in all material respects, the
information set forth therein. /s/    GRANT THORNTON LLP Irvine, California
March 18, 2005 34




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\

JMAR TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
As of December 31, 2004 and 2003 2004
    
    
    2003ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    6,599,588
    
    
    $
    4,171,179Accounts receivable
    
    
    3,090,922
    
    
    
    2,802,025Inventories
    
    
    335,336
    
    
    
    307,152Prepaid expenses and other
    
    
    925,943
    
    
    
    695,170Total current assets
    
    
    10,951,789
    
    
    
    7,975,526Property and equipment, net
    
    
    879,012
    
    
    
    791,773Intangible assets, net
    
    
    537,191
    
    
    
    684,041Other assets
    
    
    642,174
    
    
    
    250,936Goodwill
    
    
    4,415,932
    
    
    
    3,790,907TOTAL ASSETS
    
    $
    17,426,098
    
    
    $
    13,493,183LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    943,027
    
    
    $
    1,102,873Accrued liabilities
    
    
    693,311
    
    
    
    491,920Accrued payroll and related costs
    
    
    731,718
    
    
    
    527,343Billings in excess of cost incurred
    
    
    861,383
    
    
    
    69,796Current portion of notes payable and other liabilities
    
    
    145,019
    
    
    
    2,395,445Current liabilities of discontinued operations, including notes payable
    
    
    396,949
    
    
    
    960,983Total current liabilities
    
    
    3,771,407
    
    
    
    5,548,360Notes payable and other long-term liabilities, net of current portion
    
    
    465,492
    
    
    
    449,873Redeemable convertible preferred stock, 908,333 shares issued and outstanding
as of December 31, 2004 and 350,000 shares issued and outstanding as of
December 31, 2003, net of unamortized discount of $996,059 and $1,282,850, respectively
    
    
    8,087,274
    
    
    
    2,217,150Commitments and contingencies
    
    
    
    
    
    
    Stockholders equity:Preferred stock, $.01 par value; 5,000,000 shares authorized; 908,333 issued and
outstanding as of December 31, 2004 included in redeemable convertible preferred
stock above, and 350,000 issued and outstanding as of December 31, 2003
    
    
    
    
    
    
    Common stock, $.01 par value; 80,000,000 shares authorized;
Issued and outstanding 31,376,735 shares as of December 31, 2004 and
27,654,845 shares as of December 31, 2003
    
    
    313,767
    
    
    
    276,548Additional paid-in capital
    
    
    70,087,057
    
    
    
    62,420,135Accumulated deficit
    
    
    (65,298,899
    )
    
    
    (57,418,883
    )Total stockholders equity
    
    
    5,101,925
    
    
    
    5,277,800TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    17,426,098
    
    
    $
    13,493,183
 
 The accompanying notes to these consolidated financial statements are an integral part of
these consolidated balance sheets. 35




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JMAR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2004, 2003 and 2002 
 2004
    
    
    2003
    
    
    2002Revenues
    
    $
    10,059,839
    
    
    $
    17,296,508
    
    
    $
    18,383,810Costs of revenues
    
    
    8,061,099
    
    
    
    13,331,881
    
    
    
    14,970,318Gross profit
    
    
    1,998,740
    
    
    
    3,964,627
    
    
    
    3,413,492Operating expenses:Selling, general and administrative
    
    
    4,838,641
    
    
    
    4,508,152
    
    
    
    4,594,716Research and development
    
    
    1,722,329
    
    
    
    529,039
    
    
    
    854,306Deferred compensation
    
    
    
    
    
    
    
    
    
    
    1,074,324Patent and equipment writedowns
    
    
    191,575
    
    
    
    346,060
    
    
    
    Total operating expenses
    
    
    6,752,545
    
    
    
    5,383,251
    
    
    
    6,523,346Loss from operations
    
    
    (4,753,805
    )
    
    
    (1,418,624
    )
    
    
    (3,109,854
    )Realized gain on sale of marketable securities
    
    
    
    
    
    
    
    
    
    
    1,349,721Interest and other income
    
    
    158,144
    
    
    
    63,225
    
    
    
    67,404Interest and other expense
    
    
    (821,586
    )
    
    
    (731,315
    )
    
    
    (284,174
    )Loss from continuing operations before
income taxes
    
    
    (5,417,247
    )
    
    
    (2,086,714
    )
    
    
    (1,976,903
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    (484,423
    )Loss from continuing operations
    
    
    (5,417,247
    )
    
    
    (2,086,714
    )
    
    
    (2,461,326
    )Discontinued operations:Loss from operations of discontinued operations
    
    
    (214,893
    )
    
    
    (1,396,749
    )
    
    
    (5,839,367
    )Gain (loss) on disposal of discontinued operations
    
    
    
    
    
    
    205,000
    
    
    
    (3,200,000
    )Net loss
    
    
    (5,632,140
    )
    
    
    (3,278,463
    )
    
    
    (11,500,693
    )Deemed preferred stock dividends
    
    
    (2,247,876
    )
    
    
    (942,903
    )
    
    
    Loss applicable to common stock
    
    $
    (7,880,016
    )
    
    $
    (4,221,366
    )
    
    $
    (11,500,693
    )Basic and diluted loss per share:Loss per share from continuing operations
    
    $
    (0.25
    )
    
    $
    (0.12
    )
    
    $
    (0.11
    )Loss per share from discontinued operations
    
    
    (0.01
    )
    
    
    (0.04
    )
    
    
    (0.38
    )Basic and diluted loss per share applicable to common stock
    
    $
    (0.26
    )
    
    $
    (0.16
    )
    
    $
    (0.49
    )Shares used in computation of basic and diluted loss per share
    
    
    30,758,689
    
    
    
    25,618,296
    
    
    
    23,618,169
 
 The accompanying notes to these consolidated financial statements are an integral part of these
consolidated statements. 36




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
For the Years Ended December 31, 2004, 2003 and 2002 
 2004
    
    
    2003
    
    
    2002Net loss
    
    $
    (5,632,140
    )
    
    $
    (3,278,463
    )
    
    $
    (11,500,693
    )Other comprehensive loss:Holding losses
    
    
    
    
    
    
    
    
    
    
    (75,143
    )Reclassification adjustment for gains included in net loss
    
    
    
    
    
    
    
    
    
    
    (1,349,721
    )Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    (1,424,864
    )Comprehensive loss
    
    $
    (5,632,140
    )
    
    $
    (3,278,463
    )
    
    $
    (12,925,557
    )
 
 The accompanying notes to these consolidated financial statements are an integral part of these
consolidated statements. 37




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
For the Years Ended December 31, 2004, 2003 and 2002 
 AccumulatedOtherCommon Stock
    
    
    Preferred Stock

    
    
    Additional
    
    
    Comprehensive
    
    
    Accumulated
    
    
    TotalShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Paid-in
    
    
    Income
    
    
    Deficit
    
    
    EquityBalance, December 31, 2001
    
    
    22,840,392
    
    
    $
    228,404
    
    
    
    
    
    
    $
    
    
    
    $
    54,343,211
    
    
    $
    1,424,864
    
    
    $
    (41,696,824
    )
    
    $
    14,299,655Issuance of stock for services
    
    
    11,632
    
    
    
    116
    
    
    
    
    
    
    
    
    
    
    
    11,053
    
    
    
    
    
    
    
    
    
    
    
    11,169Change in unrealized gain on
marketable securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,424,864
    )
    
    
    
    
    
    
    (1,424,864
    )Issuance of common stock and
warrants
    
    
    1,000,000
    
    
    
    10,000
    
    
    
    
    
    
    
    
    
    
    
    1,769,920
    
    
    
    
    
    
    
    
    
    
    
    1,779,920Modification to existing option
and warrant terms
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    512,807
    
    
    
    
    
    
    
    
    
    
    
    512,807Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,500,693
    )
    
    
    (11,500,693
    )Balance, December 31, 2002
    
    
    23,852,024
    
    
    
    238,520
    
    
    
    
    
    
    
    
    
    
    
    56,636,991
    
    
    
    
    
    
    
    (53,197,517
    )
    
    
    3,677,994Issuance of stock and warrants
for services
    
    
    11,026
    
    
    
    110
    
    
    
    
    
    
    
    
    
    
    
    42,512
    
    
    
    
    
    
    
    
    
    
    
    42,622Issuance of common stock from
preferred stock conversions
(net of costs of $46,267)
    
    
    2,272,727
    
    
    
    22,727
    
    
    
    
    
    
    
    
    
    
    
    1,931,006
    
    
    
    
    
    
    
    
    
    
    
    1,953,733Issuance of common stock from
working capital line
conversions
    
    
    1,275,000
    
    
    
    12,750
    
    
    
    
    
    
    
    
    
    
    
    1,160,250
    
    
    
    
    
    
    
    
    
    
    
    1,173,000Beneficial conversion feature of
preferred stock and working
capital line, and fair value of
warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,262,240
    
    
    
    
    
    
    
    
    
    
    
    2,262,240Issuance of common stock and
warrants for cash
    
    
    100,000
    
    
    
    1,000
    
    
    
    
    
    
    
    
    
    
    
    99,000
    
    
    
    
    
    
    
    
    
    
    
    100,000Stock issued upon exercise of
warrant
    
    
    144,068
    
    
    
    1,441
    
    
    
    
    
    
    
    
    
    
    
    288,136
    
    
    
    
    
    
    
    
    
    
    
    289,577Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (942,903
    )
    
    
    (942,903
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    (3,278,463
    )
    
    
    (3,278,463
    )Balance, December 31, 2003
    
    
    27,654,845
    
    
    
    276,548
    
    
    
    
    
    
    
    
    
    
    
    62,420,135
    
    
    
    
    
    
    
    (57,418,883
    )
    
    
    5,277,800Issuance of stock and warrants
for services
    
    
    11,604
    
    
    
    117
    
    
    
    
    
    
    
    
    
    
    
    142,083
    
    
    
    
    
    
    
    
    
    
    
    142,083Issuance of common stock from
preferred stock conversions
(net of costs of $96,584)
    
    
    2,003,205
    
    
    
    20,032
    
    
    
    
    
    
    
    
    
    
    
    3,383,384
    
    
    
    
    
    
    
    
    
    
    
    3,403,416Issuance of common stock from
working capital line
conversions
    
    
    1,048,913
    
    
    
    10,489
    
    
    
    
    
    
    
    
    
    
    
    1,244,011
    
    
    
    
    
    
    
    
    
    
    
    1,254,500Beneficial conversion feature of
preferred stock and working
capital line, and fair value of
warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,772,225
    
    
    
    
    
    
    
    
    
    
    
    1,772,225Issuance of common stock
related to SAL earn-out
    
    
    593,787
    
    
    
    5,938
    
    
    
    
    
    
    
    
    
    
    
    986,335
    
    
    
    
    
    
    
    
    
    
    
    992,273Repurchase of stock
    
    
    (7,552
    )
    
    
    (76
    )
    
    
    
    
    
    
    
    
    
    
    (17,671
    )
    
    
    
    
    
    
    
    
    
    
    (17,747
    )Stock issued upon exercise of
options
    
    
    71,933
    
    
    
    719
    
    
    
    
    
    
    
    
    
    
    
    156,555
    
    
    
    
    
    
    
    
    
    
    
    157,274Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,247,876
    )
    
    
    (2,247,876
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,632,140
    )
    
    
    (5,632,140
    )Balance, December 31, 2004
    
    
    31,376,735
    
    
    $
    313,767
    
    
    
    
    
    
    $
    
    
    
    $
    70,087,057
    
    
    $
    
    
    
    $
    (65,298,899
    )
    
    $
    5,101,925
 
 The accompanying notes to these consolidated financial statements are an integral part of these
consolidated statements. 38




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2004, 2003 and 2002 
 2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Loss from continuing operations
    
    $
    (5,417,247
    )
    
    $
    (2,086,714
    )
    
    $
    (2,461,326
    )Adjustments to reconcile loss from continuing operations to net cash
used in continuing operations:Depreciation, amortization and debt discount
    
    
    1,013,571
    
    
    
    938,718
    
    
    
    777,317Services received in exchange for
common stock or warrants
    
    
    142,083
    
    
    
    42,622
    
    
    
    11,169Gain on sale of marketable securities
    
    
    
    
    
    
    
    
    
    
    (1,349,721
    )Deferred compensation
    
    
    
    
    
    
    
    
    
    
    512,807Patent and equipment write-downs
    
    
    191,575
    
    
    
    346,060
    
    
    
    Change in assets and liabilities:Accounts receivable
    
    
    (288,897
    )
    
    
    92,368
    
    
    
    1,307,241Inventories
    
    
    18,597
    
    
    
    82,315
    
    
    
    (94,983
    )Prepaid expenses and other
    
    
    (475,924
    )
    
    
    (133,233
    )
    
    
    390,889Customer deposits
    
    
    
    
    
    
    (832,607
    )
    
    
    (647,779
    )Billings in excess of costs incurred
    
    
    791,587
    
    
    
    (853,698
    )
    
    
    Accounts payable and accrued liabilities
    
    
    261,548
    
    
    
    (1,175,069
    )
    
    
    1,078,871Net cash used in continuing operations operating activities
    
    
    (3,763,107
    )
    
    
    (3,579,238
    )
    
    
    (475,515
    )Loss from discontinued operations
    
    
    (214,893
    )
    
    
    (1,191,749
    )
    
    
    (9,039,367
    )Changes in net assets and liabilities of discontinued operations
    
    
    (564,034
    )
    
    
    (824,732
    )
    
    
    5,143,770Net cash used in discontinued operations
    
    
    (778,927
    )
    
    
    (2,016,481
    )
    
    
    (3,895,597
    )Net cash used in operating activities
    
    
    (4,542,034
    )
    
    
    (5,595,719
    )
    
    
    (4,371,112
    )Cash flows from investing activities:Proceeds from sale of marketable securities
    
    
    
    
    
    
    
    
    
    
    1,399,746Capital expenditures
    
    
    (408,038
    )
    
    
    (123,393
    )
    
    
    (393,564
    )Additions of intangible assets, other assets and goodwill
    
    
    (359,347
    )
    
    
    (272,304
    )
    
    
    (204,157
    )Payments received on notes receivable
    
    
    62,500
    
    
    
    
    
    
    
    Net cash provided by (used in) investing activities
    
    
    (704,885
    )
    
    
    (395,697
    )
    
    
    802,025Cash flows from financing activities:Net proceeds from the issuance of preferred stock
    
    
    9,070,870
    
    
    
    5,202,333
    
    
    
    Cash payments of preferred stock dividends
    
    
    (249,760
    )
    
    
    (78,479
    )
    
    
    Payments of notes payable and other long-term liabilities
    
    
    (868,642
    )
    
    
    
    
    
    
    (41,463
    )Preferred stock redemptions
    
    
    (416,667
    )
    
    
    
    
    
    
    Repurchase of stock
    
    
    (17,747
    )
    
    
    
    
    
    
    Net proceeds from the issuance of common stock
    
    
    
    
    
    
    1,238,899
    
    
    
    1,779,920Net payments under line of credit
    
    
    
    
    
    
    (285,999
    )
    
    
    (1,450,000
    )Decrease in restricted cash
    
    
    
    
    
    
    1,550,000
    
    
    
    1,450,000Net proceeds from the exercise of options and warrants
    
    
    157,274
    
    
    
    289,577
    
    
    
    Net cash provided by financing activities
    
    
    7,675,328
    
    
    
    7,916,331
    
    
    
    1,738,457Net increase (decrease) in cash and cash equivalents
    
    
    2,428,409
    
    
    
    1,924,915
    
    
    
    (1,830,630
    )Cash and cash equivalents, beginning of period
    
    
    4,171,179
    
    
    
    2,246,264
    
    
    
    4,076,894Cash and cash equivalents, end of period
    
    $
    6,599,588
    
    
    $
    4,171,179
    
    
    $
    2,246,264Cash paid during the year for interest
    
    $
    242,265
    
    
    $
    314,218
    
    
    $
    183,466
 
 SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITY: During the years ended December 31, 2004 and 2003,
the holder of the Convertible Preferred Stock converted $3,500,000 and $2,000,000, respectively, of
the preferred stock into 2,003,205 and 2,272,727 shares, respectively, of common stock of the
Company. The Company recorded a discount of $1,772,225 and $2,251,967 representing the beneficial
conversion feature of the redeemable convertible preferred stock and debt and the fair value of
warrants issued in connection with the preferred stock and debt transactions in 2004 and 2003,
respectively (see Notes 8 and 11). In addition, during the year ended December 31, 2004, $1,254,500
of the Companys working capital line of credit was converted into 1,048,913 shares of common stock
of the Company (see Note 8). Also, during the year ended December 31, 2004, the Company repaid
$364,239 in convertible notes and $3,034 in accrued interest with the issuance of 118,121 shares of
common stock (see Note 8). During the year ended December 31, 2004, the Company issued 475,666
shares of common stock to the former shareholders and creditors of SAL, Inc. in full satisfaction
of outstanding earn-outs relating to the acquisition of SAL, Inc. (see Note 11). 
 The accompanying notes to these consolidated financial statements are an integral part of these
consolidated statements. 39




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##### Table of Contents



JMAR TECNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003 1. Description of the Company The accompanying consolidated financial statements include the accounts of JMAR Technologies,
Inc. (the Company or JMAR) and its subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation. JMAR Technologies, Inc. is a leading innovator in the development of laser-based equipment for
imaging, analysis and fabrication at the nano-scale. The Company is leveraging over a decade of
laser and photonics research to develop a diverse portfolio of products with commercial
applications in rapidly growing industries while continuing to carry out research and development
for the U.S. Defense Advanced Research Projects Agency (DARPA) and support for the U.S.
Governments Defense Microelectronics Activity (DMEA) semiconductor fabrication facility. JMAR is
targeting the nanotechnology, bioscience and semiconductor industries with its
BritelightTM Laser; X-ray Light Source; Compact X-ray Microscope  for 3D visualization
of single cells and polymers; and its X-ray Nano Probe  enabling interaction, analysis and
materials modification at the nano-scale. JMAR also develops, manufactures and markets its
BioSentryTM microorganism early warning system and maintains a strategic alliance for
the production of the READ chemical sensor for homeland security, environmental and utility
infrastructure industries. 2. Summary of Significant Accounting Policies a. Cash and Cash Equivalents The Company defines cash and cash equivalents to include cash on hand and cash invested in
short-term securities that 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. Pervasiveness of Estimates The preparation of financial statements in conformity with accounting principles generally
accepted in the United States 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. d. 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. Quarterly, any
known excess and/or obsolete inventory, based on changes in the business or other factors, are
evaluated and the reserve increased accordingly, or inventory is written down to reflect its new
cost basis. Once written down, the carrying value of inventory is not increased. 40




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) e. Income Taxes The Company accounts for income taxes in accordance with Statement of Financial Accounting
Standards (SFAS) No. 109. Under the asset and liability method of SFAS No. 109, deferred tax assets
and liabilities are recognized for the future tax consequences attributable to temporary
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 No. 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. JMAR records a valuation allowance to reduce its deferred tax assets to the amount that
management believes is more likely than not to be realized in the foreseeable future, based on
estimates of foreseeable future taxable income and taking into consideration historical operating
information. In the event management estimates that it will not be able to realize all or part of
its net deferred tax assets in the foreseeable future, a valuation allowance is recorded through a
charge to income in the period such determination is made. Likewise, should management estimate
that it will be able to realize its deferred tax assets in the future in excess of its net recorded
asset, an adjustment to reduce the valuation allowance would increase income in the
period such determination is made. f. Property and Equipment Property and equipment are recorded at cost. Depreciation and amortization are provided over
the assets 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. Leasehold improvements are amortized over
the shorter of the assets estimated useful life or the life of the related lease. g. Goodwill and Other Intangible Assets In accordance with SFAS 142, the Company has established reporting units and applies a
two-step fair value approach to evaluating goodwill impairment, using at least an annual
assessment. The Company compares the fair value of the business unit with the carrying amount of
the assets associated with the business unit. The fair value of each business unit is determined
using a risk adjusted discount rate to compute a net present value of estimated future cash flows
and a consideration of market capitalization of the Company. The second step measures the amount of
the impairment, if any. Management
performed an interim evaluation of goodwill as of June 30, 2004
following notification that no additional funding was included in the
Governments fiscal year 2005 budget. A further evaluation of
goodwill was performed again as of December 31, 2004. The business units currently
identified are Vermont Operations/Research Division, Microelectronics Division and Sensor Products
Group. All of the Companys goodwill arose from the acquisition of SAL, Inc. (the predecessor to
the Vermont Operations) and is allocated to the Vermont Operations/Research Division business unit.
The Research Division and Vermont Operations are viewed as one business unit due to the
interrelations of their businesses (i.e., X-ray source related commercialization, including the XRM
and XNP products, with the source and technology development coming from the Research Division and
the product design, manufacturing engineering, integration, testing and manufacturing performed by
the Vermont Operations, as well as the zone plate optics development and manufacturing for the XRM
and XNP performed by the Vermont Operations). Additionally, the Vermont Operations will use its
core capabilities to perform manufacturing for other products of the Company, as well as performing
contract manufacturing for other companies products. 41




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) The discounted cash flow analysis is based on a 7-year projection of revenue, operating
expenses, capital expenditures, and working capital requirements and a continuity value of 5 times
the 7th year cash flow. The discount rate used for the most recent analysis is 30%,
taking into account the riskiness of the new products. Sensitivity analysis is also performed to
determine the appropriateness of the assumptions used in the discounted cash flow analysis. As a
majority of the Companys expected revenues in the future are based on products that are currently
under development, the Company estimates the expected revenues based on its current knowledge of
the market and our expectations of successfully penetrating those markets. If our future cash flows
vary significantly from our assumptions, we may record an impairment of goodwill. The market capitalization test is used as a complementary test to the discounted cash flow
analysis. The Company estimates its market capitalization based on the average stock price over the
preceding year and estimates the three business units relative contribution to the market value of
the Company based on shareholder inquiries, emphasis by the Company in discussions with
shareholders and others, and emphasis in formal shareholder communications (i.e., press releases). h. Intangible Assets Capitalized patent costs are amortized over ten years, and other intangible assets are
amortized over not more than five years. Accumulated amortization of intangible assets was $947,091
and $784,083 at December 31, 2004 and 2003, respectively. Capitalized patent costs are reviewed
quarterly for utilization and recoverability. i. Long-Lived Assets The Company periodically evaluates the carrying value of its long-lived assets and applies the
provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Under
SFAS No. 144, long-lived assets and certain identifiable assets to be held and used in operations
are reviewed for impairment whenever events or circumstances indicate that the carrying amount of
an asset may not be fully recoverable. An impairment loss is recognized if the sum of the expected
long-term, undiscounted cash flows is less than the carrying amount of the long-lived assets being
evaluated. Management believes the carrying value of its long-lived assets does not exceed their
estimated net realizable value. The net assets and liabilities of a disposal group classified as held for sale is presented
separately in the asset and liability sections of the consolidated balance sheet. The major classes
of assets and liabilities classified as held for sale are separately disclosed in the notes to
financial statements. In accordance with SFAS No. 144, the Company classifies assets held for sale
when management commits to a plan of disposal, the disposal group is available for immediate sale
and an active plan to locate a buyer has been initiated. j. Revenues For each of the three years ended December 31, 2004, 2003 and 2002, in excess of 95% of the
Companys revenues were contract revenues, with the remainder mostly spare parts sales and service.
Contract revenues are recognized based on the percentage of completion method wherein income is
recognized pro-rata over the life of the contract based on the ratio of total incurred costs to
anticipated total costs of the contract. Actual costs could differ from these estimated costs.
Reimbursable or recoverable general and administrative (G&A) costs are charged to G&A expense as
incurred. Estimated losses are fully charged to operations when identified. 42




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) k. Beneficial Conversion Feature and Warrant Valuation In accordance with Financial Accounting Standards Board (FASB) Emerging Issues Task Force
Issue (EITF) No. 98-5 and EITF No. 00-27, the Company records a beneficial conversion feature (BCF)
related to the issuance of convertible preferred stock and convertible debt that have conversion
features at fixed rates that are in-the-money when issued and records the fair value of warrants
issued with those instruments. The BCF for the convertible instruments is recognized and measured
by allocating a portion of the proceeds to warrants and as a reduction to the carrying amount of
the convertible instrument equal to the intrinsic value of the conversion features, both of which
are credited to paid-in-capital. The Company calculates the fair value of warrants issued with the
convertible instruments using the Black Scholes valuation method, using the same assumptions used
for valuing employee options for purposes of SFAS #123 (see Note 1m),
except that the contractual life
of the warrant is used. For convertible preferred stock and related warrants, the recorded discount is recognized as a
dividend from the date of issuance to the earlier of the redemption dates or the conversion dates
using the effective yield method. For convertible debt and related warrants, the recorded discount
is recognized as interest expense from the date of issuance to the earlier of the maturity date of
the debt or the conversion dates using the effective interest yield method. l. Earnings Per Share The Company accounts for earnings per share in accordance with SFAS No. 128, Earnings per
Share. Basic earnings per common share were computed by dividing loss applicable to common stock
by the weighted average number of shares of common stock outstanding during the year. For the years
ended December 31, 2004, 2003 and 2002, the denominator in the diluted loss per share computation
was the same as the denominator for basic loss per share due to antidilutive effects of the
Companys warrants, stock options, convertible debt and convertible preferred stock. As of December
31, 2004, 2003 and 2002, the Company had shares issuable under outstanding warrants, stock options,
convertible debt and convertible preferred stock of 7,982,506, 8,124,184 and 4,647,075,
respectively, all of which are antidilutive and were excluded from the computation of diluted loss
per share. m. Stock Options The Company has adopted the disclosure only requirements of SFAS No. 123, Accounting for
Stock-Based Compensation. Options and warrants issued to non-employees (other than directors) are
accounted for based on the fair value of the equity instrument issued. The fair value is computed
using the Black Scholes pricing model. The resulting value is amortized over the service period. The Company accounts for these plans under APB Opinion No. 25, using the intrinsic value
method, under which no compensation cost has been recognized for issuance to employees. Had
compensation cost for these plans been determined using the fair value method under SFAS No. 123,
the Companys loss applicable to common stock and loss per share would have been the following pro
forma amounts (unaudited): 43




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) 2004
    
    
    2003
    
    
    2002Loss applicable to
common stock:
    
    As Reported
    
    $
    (7,880,016
    )
    
    $
    (4,221,366
    )
    
    $
    (11,500,693
    )Stock based
compensation
expense
    
    
    
    
    (816,710
    )
    
    
    (1,028,140
    )
    
    
    (1,940,999
    )Pro Forma
    
    $
    (8,696,726
    )
    
    $
    (5,249,506
    )
    
    $
    (13,441,692
    )Basic and
diluted loss per share:
    
    As Reported
    
    $
    (0.26
    )
    
    $
    (0.16
    )
    
    $
    (0.49
    )Stock based
compensation expense
    
    
    
    
    (0.02
    )
    
    
    (0.04
    )
    
    
    (0.08
    )Pro Forma
    
    $
    (0.28
    )
    
    $
    (0.20
    )
    
    $
    (0.57
    )
 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 2004, 2003 and 2002: risk-free interest rate of approximately 4.41 percent in 2004, 2.74 percent
in 2003 and 4 percent in 2002; expected dividend yields of 0 percent and expected lives of 6 years.
For grants in 2004, 2003 and 2002, the expected volatility used was 255 percent, 275 percent, 142
percent, respectively. n. Comprehensive Income (Loss) SFAS No. 130, Reporting Comprehensive Income, establishes standards for reporting and
display of comprehensive income and its components (revenues, expenses, gains and losses). This
statement requires that an enterprise: (a) classify the items of other comprehensive income by
their nature in a financial statement; and (b) display the accumulated balance of other
comprehensive income separately from stockholders equity in the equity section of the balance
sheet. The unrealized gain (loss) for the year ended December 31, 2002 results from changes in the
value of the Companys investment in Bede plc. o. Reclassifications Certain reclassifications have been made to the prior year financial statements to conform
with the 2004 presentation. p. Recent Accounting Pronouncements In December 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No.
123(R), Share-Based Payment, (SFAS No. 123(R)) which is a revision of SFAS No. 123. SFAS No.
123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB
Statement No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R) is similar
to the approach described in SFAS 123. However, SFAS No. 123(R) requires all share-based payments
to employees, including grants of employee stock options, to be recognized in the income statement
based on their fair values. Pro forma disclosure is no longer an alternative. SFAS No. 123(R) must
be adopted no later than July 1, 2005. Management is still evaluating the methodology to be used
and has not determined the impact on the Companys financial statements in the future. However,
based upon the proforma disclosures in Note 2(m), management anticipates that the impact could be
as much as $1 million annually for currently outstanding options. In November 2004, the FASB issued FASB Statement No. 151, Inventory Costs, an amendment of
ARB No. 43, Chapter 4, which is effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. The amendments made by Statement 151 will improve financial
reporting by clarifying that abnormal amounts of idle facility expense, freight, handling costs,
and wasted materials (spoilage) should be recognized as current-period charges
and by requiring the allocation of fixed production overheads to inventory based on the normal
capacity of 44




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) the production facilities. The Company does not believe that the adoption of Statement
151 will have a significant effect on its financial statements. 3. Acquisitions Semiconductor Advanced Lithography, Inc. On August 7, 2001, the Companys wholly owned subsidiary, JMAR/SAL NanoLithography, Inc.
(Subsidiary) acquired all of the outstanding equity of Semiconductor Advanced
Lithography, Inc. (SAL), in a merger of SAL with and into Subsidiary
(Acquisition). SAL (subsequently
renamed JMAR/SAL NanoLithography, Inc. or JSAL) is a provider of XRL stepper systems and the
leading developer of CPL systems. Consideration for the Acquisition consisted of an aggregate of 603,051
shares of the Companys common stock valued at $1.7 million, $1.2 million in cash and $1.2 million
in notes (SAL Notes). The SAL Notes were repaid in February 2004, plus accrued interest, by
retiring a total of $364,239 in notes and $3,034 in accrued interest with the issuance of 118,121
shares of common stock valued at $3.11 per share and repaying the remaining amount of $835,761 in
notes and accrued interest of $6,961 with cash. The $3.11 per share value was calculated based on
85 percent of the 5 day average closing prices of the Companys common stock prior to the last day
for the SAL Noteholders to accept the offer. This formula was based on negotiations between the
Company and the Noteholders representative. All stock options and warrants issued by SAL which
were outstanding immediately prior to the Acquisition were either exercised pursuant to their terms
or were terminated. There were no settlements of options or warrants and there was no increase to
JMARs purchase price as a result of the issuance of additional SAL shares upon exercise of the
outstanding options and warrants. The Company accounted for the Acquisition as a purchase and, accordingly, results of
operations of JSAL have been included in the consolidated financial statements since August 7,
2001. The allocation of the original purchase price of $4,297,414 (including transaction costs) is
as follows: Goodwill
    
    $
    3,790,907Identifiable intangibles
    
    
    785,000Fair value of tangible assets acquired
    
    
    671,593Liabilities assumed
    
    
    (950,086
    )$
    4,297,414
 Under the Merger Agreement entered into in August, 2001 with the former shareholders and
creditors of SAL, Inc. (now operating as the Companys Vermont Operations), those persons could
have earned up to three contingent earn-out payments upon the satisfaction of certain conditions
related to the development and sale of CPL lithography systems. The first earn-out was not achieved
by the deadline and, therefore, was not earned by the SAL investors. Based on the uncertainties of market acceptance of the CPL technology and delays in the
completion of the CPL system, which operated to delay the achievement of the second and third
earn-outs, on July 9, 2004, the Company sent a letter to former shareholders and creditors
(Holders) of SAL, Inc. proposing a final resolution of the second and third earn-outs through
payment of a total of $625,000 in shares of common stock, valued at the average of the closing
prices of JMARs common stock for the five days during the period August 18, 2004 to August 24,
2004. Holders of more than 99 percent of the earn-out interests accepted the Companys offer to
receive the final payment of $625,000 in common stock in full satisfaction of all remaining amounts
owed under the Merger Agreement. The additional consideration of $625,000 is included in goodwill
on the accompanying Balance Sheet (see Note 11). 45




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) 4. Accounts Receivable At December 31, 2004 and 2003, accounts receivable consisted of the following: 2004
    
    
    2003Billed
    
    $
    944,046
    
    
    $
    1,068,628Unbilled
    
    
    2,146,876
    
    
    
    1,733,397$
    3,090,922
    
    
    $
    2,802,025
 All unbilled receivables at December 31, 2004 are expected to be billed and collected
within one year. Payments to the Company for performance on certain U.S. Government contracts is
subject to progress payment audits by the Defense Contract Audit Agency and are recorded at the
amounts expected to be realized. Included in the unbilled amount is $1,269,000 related to the
Companys contract with DARPA (see Note 16). Of the remaining balance of unbilled receivables,
$329,912 is related to withheld fees for prior contracts to be billed pending DCAA audit, and
$547,964 is related to the normal billing cycle and timing of billings. 5. Inventories At December 31, 2004 and 2003, inventories consisted of the following: 2004
    
    
    2003Raw materials, components and sub-assemblies
    
    $
    88,684
    
    
    $
    214,694Work-in-process
    
    
    245,498
    
    
    
    87,981Finished goods
    
    
    1,154
    
    
    
    4,477$
    335,336
    
    
    $
    307,152
 Work-in-process increased between 2004 and 2003 due to work performed related to two
laser system orders received in 2004. 6. Property and Equipment At December 31, 2004 and 2003, property and equipment consisted of the following: 2004
    
    
    2003Equipment and machinery
    
    $
    3,156,252
    
    
    $
    2,774,470Furniture and fixtures
    
    
    440,990
    
    
    
    435,043Leasehold improvements
    
    
    283,218
    
    
    
    280,2833,880,460
    
    
    
    3,489,796Less-Accumulated depreciation
    
    
    (3,001,448
    )
    
    
    (2,698,023
    )$
    879,012
    
    
    $
    791,773
 During 2003, the Company wrote-off a modular clean room asset of the Research Division in
the amount of $200,056. Because of the evolution of the Companys business, management determined
that this asset would not be required in the future. The asset was disposed of in 2003, at no
recovery to the Company. This write-off is included in patents and equipment write-downs in the
accompanying Statements of Operations. 46




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) 7. Commitments and Contingencies a. Leases The Company leases its office facilities under various operating leases expiring through May,
2006. Minimum future rental payments for non-cancelable leases as of December 31, 2004, are as
follows: Year Ending December 31,2005
    
    $
    664,8052006
    
    
    76,6582007
    
    
    13,7492008
    
    
    13,6572009
    
    
    5,085$
    773,954
 Related rent expense was $1,158,507, $1,193,998 and $1,185,303 for the years ended
December 31, 2004, 2003 and 2002, respectively. b. Deferred Compensation Pursuant to an Employment Agreement dated September, 2001 with Dr. Martinez, the Companys
former Chairman and Chief Executive Officer, if the Company delivered notice of its intention not
to renew or discontinued his status of Chairman or CEO, or both, other than for cause, then Dr.
Martinezs employment was to continue for three years at the highest total compensation rate
(including bonuses, director fees and similar payments) he had received in any previous 12 month
period. This amount was approximately $375,000 per annum. In such event, the Company also agreed to
maintain comparable medical insurance benefits for such three year period. In May, 2002, Dr. Martinez informed the Board of Directors of his desire to retire. The Board
and Dr. Martinez engaged in discussions regarding Dr. Martinezs future role with the Company. In
order to set a definite date for the transition to a new CEO, in July, 2002, the Board of Directors
exercised the Companys rights under the Employment Agreement to discontinue Dr. Martinezs status
as CEO effective August 16, 2002. Following negotiations between Dr. Martinez and the Board, an
agreement was reached to restructure this payment obligation to spread the payments over six years
to reduce the impact of the original agreement on the Companys cash flow. In consideration for
this modification, the Company will provide comparable medical insurance benefits for six years,
and modified 942,242 of the outstanding options and warrants held by Dr. Martinez to (1) vest all
unvested options and warrants (141,269 options), (2) provide that, for those options that have an
expiration date within the next six years, the early termination provision that would otherwise
have resulted in the termination of the options and warrants 60 days after termination of his
employment was waived, and (3) provide that all remaining options and warrants will expire on the
later of August 15, 2008 or 60 days after Dr. Martinez ceases to be a director. The Company
recorded a charge in 2002 in the amount of $1,074,324 resulting from this event. The charge
includes $561,517 for the discounted deferred compensation payments over six years, using a
discount rate of 30 percent, and $512,807 for the intrinsic value of Dr. Martinezs options and
warrants resulting from the modification of those options and warrants. The Company also has a deferred compensation arrangement with a former employee for amounts
withheld by that employee from his pay. The amount of the discounted liability for this employee
included on the accompanying Balance Sheet at December 31, 2004 is $160,638. The Company recorded interest expense of $180,126, $171,358 and $48,159 in 2004, 2003 and
2002, respectively, for the amortization of the discounts. Total deferred compensation 47




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) obligations
for 2005 through 2009 are $282,377, $269,377, $269,377, $184,484 and $56,003, respectively. The
Company has accounted for these individual deferred compensation arrangements in accordance with
Accounting Principles Board Nos. 12 and 21. 8. Notes Payable and Other Long-term Obligations Notes payable and other long-term obligations as of December 31, 2004 and 2003, were as
follows: 2004
    
    
    2003Working capital line with Laurus in
the amount of $3,000,000. Advances
bear interest at the prime rate (5.25%
and 4% at December 31, 2004 and 2003,
respectively) plus .75%, but not less
than 5%. Interest on the line is
payable monthly. Advances are secured
by all assets of the Company.
Borrowings may be converted to common
stock
    
    $
    
    
    
    $
    1,140,431Convertible notes payable issued to
former shareholders and creditors of
SAL, Inc. bearing interest at 8%
interest due quarterly, principal
paid in February 2004
    
    
    
    
    
    
    1,200,000Deferred compensation, less discount
of $451,107 and $477,875 at December
31, 2004 and 2003, respectively (see
Note 7)
    
    
    610,511
    
    
    
    504,887610,511
    
    
    
    2,845,318Less: Current portion
    
    
    (145,019
    )
    
    
    (2,395,445
    )$
    465,492
    
    
    $
    449,873
 In March 2003, the Company entered into a Revolving Fixed Price Convertible Note (Working
Capital Line) with Laurus Master Fund (Laurus). As of December 31, 2004 there was no amount
outstanding under the Working Capital Line. The Working Capital Line allows the Company to borrow
from time-to-time up to 85% of eligible accounts receivable of the Company to a maximum of $3
million. Advances in excess of this formula are allowed, however, with the consent of Laurus.
Laurus can convert any portion of the principal outstanding to common stock at a fixed price per
share (Conversion Price) any time the market price of the Companys common stock is in excess of
the Conversion Price. The Company can convert a portion of the principal outstanding to common
stock at the Conversion Price if the market price of the Companys common stock averages 118% of
the Conversion Price or higher for 22 consecutive trading days. The initial terms of the Working
Capital Line provided that after $2 million of conversions into equity, the Conversion Price would
be increased. The Conversion Price initially was $.92, but was increased to $2.85 in January 2004
after $2 million of the Working Capital Line had been converted at which time the Company granted
additional warrants for the purchase of 100,000 shares of its common stock. For the years ended
December 31, 2004 and 2003, $1,254,500 and $1,173,000, respectively, of the Working Capital Line
was converted into 1,048,913 and 1,275,000 shares of common stock, respectively (see Note 11). The
interest rate on the Working Capital Line is equal to the prime rate
(5.25% at December 31,
2004) plus 0.75 percent, subject to a floor of 5.00 percent. Accrued interest is payable monthly.
The Working Capital Line requires that the Companys quick ratio, as defined, be 0.90 or higher.
The quick ratio is defined as the sum of cash and accounts receivable divided by the
sum of current liabilities, exclusive of current liabilities of discontinued operations. The
Companys quick ratio was 2.87 at December 31, 2004. The term of the Working Capital Line expires
March, 2006. The available borrowings under the Working Capital Line were approximately $2.6
million at December 31, 2004, based on the amount of eligible accounts receivable at that date, all
of which was unused at December 31, 2004. 48




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) In connection with the Working Capital Line, the Company issued warrants to Laurus to purchase
400,000 and 100,000 shares of common stock in March 2003 and January 2004, respectively, at prices
ranging from $1.06 to $5.15 and paid fees of $74,400 in March 2003. In connection with the March
2003 issuance, the Company recorded a discount of $152,318, representing the intrinsic value of the
beneficial conversion feature and a discount of $250,144, representing the fair value of the
400,000 warrants. For the January 2004 issuance, the Company recorded a discount of $254,691
representing the intrinsic value of the beneficial conversion feature and a discount of $248,070,
representing the fair value of the 100,000 warrants. The fair value of each warrant grant is
estimated on the date of issuance using the Black Scholes pricing model with the following
assumptions: risk-free interest rate of 2.7 percent for the 2004 warrant and 4.0 percent for the
2003 warrant; expected dividend yield of 0 percent; expected life of 7 years; and expected
volatility of 258 percent for the 2004 warrant and 251 percent for the 2003 warrant. At December
31, 2004, the unamortized discount and fees of $260,125 was included in prepaid expenses and
other in the accompanying Consolidated Balance Sheet. In addition, there will be an additional
beneficial conversion feature in the amount of $210,923 recorded as additional borrowings are made
against the Working Capital Line. The discount is amortized over the remaining life of the Working
Capital Line or upon conversion, resulting in $442,029 and $289,063 of interest expense for the
years ending December 31, 2004 and 2003, respectively. Also included in the discount are other fees
paid to Laurus, including annual renewal fees. The weighted average interest rate on the Laurus Line was 5%for 2004 and 2003. The maximum
amount outstanding was $1,319,208 and $2,485,255 for 2004 and 2003, respectively, and the average
amount outstanding was approximately $39,677 and $1,263,000 during 2004 and 2003, respectively. The
effective interest rate, including the amortization of the beneficial conversion feature and fair
value of warrants was 1,322.50 percent and 41.33 percent in 2004 and 2003, respectively. The 2004 effective
interest rate was unusually high due to the low amount of borrowings required during 2004 in
comparison to the amortization of the non-cash discount related to the Laurus Line. The weighted average
interest rate on the Companys prior line of credit with Comerica Bank (Comerica Line) was 4.69%
for 2002. The maximum amount outstanding under the Comerica Line was $3,000,000 for 2002, and the
average amount outstanding was $1,393,151 during 2002. The convertible notes (SAL Notes) were issued to the former shareholders of SAL. The SAL Notes
were repaid in February 2004, plus accrued interest, by retiring a total of $364,239 in notes and
$3,034 in accrued interest with the issuance of 118,121 shares of common stock valued at $3.11 per
share and repaying the remaining amount of $835,761 in notes and accrued interest of $6,961 with
cash. The $3.11 per share value was calculated based on 85 percent of the 5 day average closing
prices of the Companys stock prior to the last day for the SAL Noteholders to accept the offer.
This formula was based on negotiations between the Company and the Noteholders representative. Interest paid for the years ended December 31, 2004, 2003 and 2002 was $242,265, $314,218 and
$183,466, respectively. 9. Discontinued Operations/Assets Held for Sale In the first quarter of 2002, the Company decided to discontinue its standard semiconductor
products business. Also, during the later half of 2002, the Company concluded that its precision
equipment business (JPSI) did not fit with the strategic direction of the
Company and that the markets for that business products would continue to be slow in the near
term. Therefore, in December, 2002, the Company decided to initiate the process of selling JPSI
and, in July 2003, the Company completed the sale of that business. The standard semiconductor products business and the precision equipment business have been
accounted for in the accompanying consolidated financial statements as discontinued operations. 49




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) The loss from operations of discontinued operations of $214,893 for the year ended December
31, 2004 is related to the standard semiconductor products business. The loss from operations of
discontinued operations of $1,396,749 for the year ended December 31, 2003 consists of $457,413
related to the standard semiconductor products business (primarily associated with the Irvine
facility) and legal costs for disputed liabilities of that business offset in part by gains from
settlement of certain liabilities. In addition, for 2003, the loss from discontinued operations
includes $939,336 related to JPSI. The loss from operations of discontinued operations of
$5,839,367 for the year ended December 31, 2002 consists of $1,856,381 related to the standard
semiconductor products business and $3,982,986 related to JPSI, including a facility reserve of
$206,000. The Company accounted for the losses of JPSI in accordance with SFAS #144, EITF #94-3 and SAB
Topic 5P and, accordingly, recorded certain of the losses in 2002 when management and the Board
agreed to a plan to discontinue these operations. The loss on disposal of
discontinued operations of $3,200,000 for the year ended December 31, 2002 relates to the sale of JPSI and
includes a write-down of inventory of $2,502,989 to estimated net realizable
value of approximately $728,000, a write-off of goodwill and other intangible assets of $370,485
and a write-off of fixed assets of $326,526. We were not able to find a buyer for the standard
semiconductor products business, accordingly, we shut the business down in mid-2002. There was no
loss on its disposal because all assets had previously been written off earlier in 2002. In July 2003, the Company sold JPSI to several private investors and recorded a gain of $205,000. Under the terms of the sale,
JMAR received $500,000 in a combination of cash and promissory notes, and the buyer assumed 14 of
the remaining 25 months of JPSIs facility lease. The notes are secured by the assets of JPSI and
the lease obligation is secured by $50,000 in cash. In addition, all JPSI receivables as of the
closing were assigned to JMAR, and JMAR agreed to pay all trade and employee related liabilities
existing as of the closing and unknown liabilities, if any. The buyers have assumed all other
ongoing commitments of JPSI. The results of operations of JPSI for 2003 through the sale date are
reported in discontinued operations in 2003. Prior to December 31, 2001, as the level of business expected from the standard semiconductor
products business did not materialize, the Company decided to take action to sublease the Irvine
facility and move the standard semiconductor products business into a smaller facility and recorded
a reserve of $547,000 against the Irvine facility lease based on an appropriate discount rate and
estimated sublease rental income. The lease provides for rent and related expenses of approximately
$36,000 per month through August 2005. In June 2004, the Company subleased the facility at a
substantial reduction from the Companys lease payment, however,
the sub-tenant defaulted on the
sublease in January 2005. The Company continues to reflect losses through December 31, 2004 on this
lease primarily because of changes to the Companys expected sublease income and because of the effect of the
discounting of the reserve liability. For the years ended December 31, 2003 and 2002, changes in
the Companys estimates of sublease income resulted in an increase in the facility reserve of
$150,000 and $300,000, respectively. In the quarter ended June 30, 2004, the Company reduced its
reserve by $112,000 when it sub-leased the facility, but increased the reserve by an equivalent
amount at December 31, 2004 when the sub-tenant defaulted. At December 31, 2004 and December 31, 2003,
net liabilities of assets discontinued and held for sale consisted of the following: 50




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) December 31,2004
    
    
    2003Current Liabilities:Facility lease accrual
    
    $
    275,221
    
    
    $
    598,466Accounts payable and accruals
    
    
    84,284
    
    
    
    230,978Employee related contractual
commitments
    
    
    
    
    
    
    10,384Note payable
    
    
    37,444
    
    
    
    121,155$
    396,949
    
    
    $
    960,983
 10. Income Taxes The tax effects of temporary differences that give rise to significant deferred tax assets and
liabilities at December 31, 2004 and 2003 are presented below: 2004
    
    
    2003Deferred tax assets:Net operating loss carryforwards
    
    $
    18,224,000
    
    
    $
    19,409,000Capital
loss carryforward
    
    
    6,843,000
    
    
    
    Other
    
    
    1,268,000
    
    
    
    575,000Total gross deferred tax assets
    
    
    26,335,000
    
    
    
    19,984,000Less valuation reserve
    
    
    (26,335,000
    )
    
    
    (19,984,000
    )Net deferred tax asset
    
    $
    
    
    
    $
    
 The valuation reserve as of December 31, 2004 and 2003 represents deferred tax assets which
management believes, based on the Companys history of operating losses, may not be realized in
future periods. The valuation allowance was increased by $6,351,000 in 2004 and decreased by
$561,000 in 2003. The capital loss carryforward relates to the sale
of JPSI, can only be applied against capital gains and expires in
2008. The final determination of the capital loss treatment was not
determined until the Companys Federal tax return was filed in September 2004. Because the Company has fully reserved for its
deferred tax assets, including the capital loss, the Company has not
updated the 2003 footnote disclosure as there is no impact on net
deferred tax asset. The effective income tax rate for the years ended December 31, 2004, 2003 and 2002 varied from
the statutory federal income tax rate as follows: 2004
    
    
    2003
    
    
    2002Statutory federal income tax rate
    
    
    (34
    )%
    
    
    (34
    )%
    
    
    (34
    )%State income tax
    
    
    (6
    )
    
    
    (6
    )
    
    
    (6
    )Valuation allowance
    
    
    
    
    
    
    
    
    
    
    25Benefit recorded due to net operating loss
carryforward position
    
    
    40
    
    
    
    40
    
    
    
    40
    %
    
    
    
    %
    
    
    25
    %
 At December 31, 2004, the Company had Federal net operating loss carryforwards expiring as
follows: 51




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) Expires2005
    
    $
    2,840,0002006
    
    
    961,0002007
    
    
    4,546,0002008
    
    
    6,932,0002009
    
    
    6,860,0002010
    
    
    2,265,0002011
    
    
    585,0002019
    
    
    731,0002020
    
    
    2,603,0002021
    
    
    1,295,0002022
    
    
    10,869,0002023
    
    
    4,597,0002024
    
    
    5,142,000Total
    
    $
    50,226,000
 In addition to the capital loss carryforward, the
Company has approximately $3,170,000 of temporary differences that will offset future
taxable income subject to the change in ownership limitations
discussed below. Also, the Company has approximately
$12.6 million of state net operating loss carryforwards that
expire from 2006 to 2014. 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, 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 $695,000 apply to approximately $3,599,000 of Company and acquired company loss
carryforwards. Approximately $46,627,000 of the net operating loss carryforwards are not subject to
annual limitations. 11. Equity Transactions a. Laurus Preferred Stock and Warrants In 2004 and 2003, the Company sold the following series of Preferred Stock to Laurus for cash: Converted in 2003
    
    
    Converted in 2004OriginalConversion
    
    
    
    
    
    
    Shares
    
    
    
    
    
    
    SharesIssuance Date
    
    Series
    
    
    Amount
    
    
    Dividend
    
    
    Price
    
    
    Amount
    
    
    Issued
    
    
    Amount
    
    
    IssuedMarch, 2003
    
    
    A
    
    
    $
    1,000,000
    
    
    
    8
    %
    
    $
    0.88
    
    
    $
    1,000,000
    
    
    
    1,136,363
    
    
    
    
    
    
    
    March, 2003
    
    
    B
    
    
    
    1,000,000
    
    
    
    3
    %
    
    $
    0.88
    
    
    
    1,000,000
    
    
    
    1,136,364
    
    
    
    
    
    
    
    September, 2003
    
    
    C
    
    
    
    1,500,000
    
    
    
    8
    %
    
    $
    2.08
    
    
    
    
    
    
    
    
    
    
    $
    1,500,000
    
    
    
    721,154December, 2003
    
    
    D
    
    
    
    2,000,000
    
    
    
    8
    %
    
    $
    1.56
    
    
    
    
    
    
    
    
    
    
    
    2,000,000
    
    
    
    1,282,051January, 2004
    
    
    E
    
    
    
    1,500,000
    
    
    
    8
    %
    
    $
    2.85
    (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February, 2004
    
    
    F
    
    
    
    2,000,000
    
    
    Prime
    (2)
    
    $
    3.11
    (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February, 2004
    
    
    G
    
    
    
    2,000,000
    
    
    Prime
    (2)
    
    $
    3.28
    (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February, 2004
    
    
    H
    
    
    
    4,000,000
    
    
    Prime
    (2)
    
    $
    3.47
    (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    15,000,000
    
    
    
    
    
    
    
    
    
    
    $
    2,000,000
    
    
    
    2,272,727
    
    
    $
    3,500,000
    
    
    
    2,003,205
 (1) Reduced to $2.00 pursuant to February 1, 2005 agreement (see
below) (2) Prime rate at
December 31, 2004 was 5.25 percent If not previously converted to common stock, the outstanding amount of Series E, F, G and H
Preferred Stock must be redeemed in cash (or it can be redeemed in common stock if the 52




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) closing
market price of the Companys common stock is 118% of the Conversion Price or higher for the 11
trading days prior to the redemption date) at various amounts and dates (see below). Conversions to
equity are offset against the required repayments. Except for the conversion price, the conversion
terms of the Series E through H Preferred Stock are the same as the conversion terms of the Working
Capital Line (see Note 8). On February 1, 2005, the Company entered into agreements with Laurus amending the Companys
Series E, F, G and H Convertible Preferred Stock (Amendments). The Amendments provide for 1) the
deferral of approximately $3.8 million in monthly redemption payments, as follows: a) payments of
the remaining 12 months of redemption payments ($83,333 per month) for the Series E Preferred Stock
are deferred until July, 2006, and b) the next 18 months of redemption payments due under the
Series F, G and H Convertible Preferred Stock ($150,000 per month) are deferred until February,
2007; 2) the grant of a right to the Company to elect to pay the originally scheduled monthly
redemption payments with shares of the Companys Common Stock valued at a 15% discount to the then
market price; and 3) the reduction in the conversion prices of the Series E-H Preferred Stock
(originally ranging from $2.85 to $3.47) to $2.00 per share. The monthly redemption payments under
the Series F-H Preferred Stock will recommence in August, 2006 until January, 2007, with the
balance of approximately $4.25 million in the stated amount of the Series F-H Preferred Stock due
in February, 2007. These redemption payments will be reduced to the extent that there are
conversions of the Preferred Stock into Common Stock. If not previously converted, the Series E through H Preferred Stock, as amended, must be
redeemed by the Company as follows: GrossAmountOutstandingat December
    
    
    Scheduled RedemptionsDescription
    
    31, 2004
    
    
    2005
    
    
    2006
    
    
    2007
    
    
    TotalSeries E Preferred
    
    $
    1,083,333
    
    
    $
    83,333
    
    
    $
    1,000,000
    
    
    $
    
    
    
    $
    1,083,333Series F Preferred
    
    $
    2,000,000
    
    
    
    37,500
    
    
    
    187,500
    
    
    
    1,775,000
    
    
    
    2,000,000Series G Preferred
    
    $
    2,000,000
    
    
    
    37,500
    
    
    
    187,500
    
    
    
    1,775,000
    
    
    
    2,000,000Series H Preferred
    
    $
    4,000,000
    
    
    
    75,000
    
    
    
    375,000
    
    
    
    3,550,000
    
    
    
    4,000,000$
    233,333
    
    
    $
    1,750,000
    
    
    $
    7,100,000
    
    
    $
    9,083,333
 In connection with all of the above financing transactions with Laurus, including related
to the Working Capital Line, the Company issued warrants to Laurus to purchase a total of 1,390,000
shares of common stock at prices ranging from $1.058 to $5.15. In addition, Laurus was granted the
right to receive a warrant to purchase one share of common stock at
$3.13 for every $20 of principal of the Working Capital Line
that is converted to equity up to a total of 50,000 shares. As of February1, 2005 all of the
preferred stock, warrants and Working Capital Line held by Laurus is convertible or exercisable
into approximately 5.8 million shares. As a result of the convertible preferred stock and warrants issued in 2004 and 2003, the
Company recorded a discount representing the beneficial conversion feature of the preferred stock
and the fair value of the warrants issued of approximately $1.3 million and $1.8 million,
respectively. The beneficial conversion feature was recognized as a reduction of preferred stock
and is amortized to loss applicable to common stock over the earlier of the redemption period or
the conversion dates. The unamortized discount, including fees and costs, was $996,059 and
$1,282,850 at December 31, 2004 and 2003, respectively. The following table summarizes the preferred stock activity for 2003: 53




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) FinancingNet BalanceatFair Value of
    
    
    Fees and
    
    
    Discount
    
    
    
    
    
    
    December 31,Series
    
    Gross Amount
    
    
    BCF
    
    
    Warrants
    
    
    Costs
    
    
    Amortization
    
    
    Conversions
    
    
    2003A
    
    $
    1,000,000
    
    
    $
    195,068
    
    
    $
    115,522
    
    
    $
    63,900
    
    
    $
    374,490
    
    
    $
    1,000,000
    
    
    $
    B
    
    
    1,000,000
    
    
    
    195,067
    
    
    
    115,522
    
    
    
    68,517
    
    
    
    379,106
    
    
    
    1,000,000
    
    
    
    C
    
    
    1,500,000
    
    
    
    379,924
    
    
    
    257,327
    
    
    
    72,000
    
    
    
    84,474
    
    
    
    
    
    
    
    875,223D
    
    
    2,000,000
    
    
    
    321,179
    
    
    
    269,896
    
    
    
    93,250
    
    
    
    26,252
    
    
    
    
    
    
    
    1,341,927$
    5,500,000
    
    
    $
    1,091,238
    
    
    $
    758,267
    
    
    $
    297,667
    
    
    $
    864,322
    
    
    $
    2,000,000
    
    
    $
    2,217,150
 The fair value of each warrant grant in 2003 was estimated on the date of issuance using
the Black Scholes pricing model with the following assumptions: risk-free interest rate ranging
from 2.7 percent to 4.0 percent; expected dividend yield of 0 percent; expected life of 7 years;
and expected volatility of 247 percent to 251 percent. The following table summarizes the preferred stock activity for 2004: FinancingNetBalance at
    
    
    
    
    
    
    
    
    
    
    Fair
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net Balance atDecember
    
    
    Gross
    
    
    
    
    
    
    Value of
    
    
    Fees and
    
    
    Discount
    
    
    
    
    
    
    
    
    
    
    December 31,Series
    
    31, 2003
    
    
    Amount
    
    
    BCF
    
    
    Warrants
    
    
    Costs
    
    
    Amortization
    
    
    Conversions
    
    
    Redemptions
    
    
    2004C
    
    $
    875,223
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    624,777
    
    
    $
    1,500,000
    
    
    $
    
    
    
    $
    D
    
    
    1,341,927
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    658,073
    
    
    
    2,000,000
    
    
    
    
    
    
    
    E
    
    
    
    
    
    
    1,500,000
    
    
    
    381,609
    
    
    
    218,451
    
    
    
    62,000
    
    
    
    331,033
    
    
    
    
    
    
    
    416,667
    
    
    
    752,306F
    
    
    
    
    
    
    2,000,000
    
    
    
    54,250
    
    
    
    144,282
    
    
    
    72,062
    
    
    
    82,686
    
    
    
    
    
    
    
    
    
    
    
    1,812,092G
    
    
    
    
    
    
    2,000,000
    
    
    
    
    
    
    
    151,571
    
    
    
    72,062
    
    
    
    68,332
    
    
    
    
    
    
    
    
    
    
    
    1,844,699H
    
    
    
    
    
    
    4,000,000
    
    
    
    
    
    
    
    319,301
    
    
    
    144,125
    
    
    
    141,603
    
    
    
    
    
    
    
    
    
    
    
    3,678,177$
    2,217,150
    
    
    $
    9,500,000
    
    
    $
    435,859
    
    
    $
    833,605
    
    
    $
    350,249
    
    
    $
    1,906,504
    
    
    $
    3,500,000
    
    
    $
    416,667
    
    
    $
    8,087,274
 The fair value of each warrant grant in 2004 was estimated on the date of issuance using
the Black Scholes pricing model with the following assumptions: risk-free interest rate of 2.7
percent; expected dividend yield of 0 percent; expected life of 7 years; and expected volatility of
258 percent to 262 percent. No beneficial conversion feature was recorded on the Series G and H
preferred stock as the conversion price was higher than the market price of the Companys common
stock at the commitment date. All of the preferred stock, warrants and the Working Capital Line (Securities) held by Laurus
contain provisions that restrict the right of Laurus to convert or exercise its JMAR securities in
order to limit its percentage beneficial ownership. If Laurus were to waive these
beneficial ownership limitations the Securities would be convertible for or exercisable into
more than 4.99% of the outstanding shares of the Companys
common stock commencing 75 days after notice of such waiver. However, Laurus has not
requested such a waiver. Laurus has also agreed that none of the Securities shall be converted or
exercised to the extent that conversion or exercise of the Securities would result in Laurus
beneficially owning more than 19.9% of the Companys outstanding number of shares of common stock
unless and until the Company obtains stockholder approval in accordance with NASDAQ corporate
governance rules, or an exemption from the applicable provision of NASDAQ corporate governance
rules. Included in the loss applicable to common stock in the accompanying Consolidated Statement of
Operations for the years ended December 31, 2004 and 2003 are preferred stock dividends of
$2,247,876 and $942,903, respectively. The amount for the years ended December 31, 2004 and 2003
represents $341,372 and $78,581, respectively, of preferred stock dividends 54




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) paid or payable in cash
and $1,906,504 and $864,322, respectively, related to the discount representing the beneficial
conversion feature of the redeemable convertible preferred stock and the fair value of warrants
issued in connection with the preferred stock. b. Issuance of Warrants A summary of the status of the total number of warrants as of December 31, 2004, 2003 and 2002
and changes during the years then ended is presented in the tables below: 2004
    
    2003
    
    2002Wtd Avg
    
    
    
    Wtd Avg
    
    
    
    Wtd AvgShares
    
    Ex Price
    
    Shares
    
    Ex Price
    
    Shares
    
    Ex PriceOutstanding at beg. of year
    
    1,830,720
    
    $
    1.37
    
    
    1,422,643
    
    $
    2.49
    
    
    1,252,643
    
    $
    2.41Granted
    
    440,000
    
    
    4.09
    
    
    1,100,000
    
    
    1.62
    
    
    170,000
    
    
    2.49Exercised
    
    (1,750
    )
    
    1.00
    
    
    (144,068
    )
    
    2.01
    
    
    
    
    
    Forfeited




1.94


(547,855
)

4.45





Outstanding at end of year
    
    2,268,970
    
    
    
    
    
    1,830,720
    
    
    
    
    
    1,422,643Exercisable at end of year
    
    2,240,345
    
    
    
    
    
    1,780,720
    
    
    
    
    
    1,422,643Weighted average fair valueof warrants granted
    
    2.94
    
    
    
    
    
    1.19
    
    
    1.42
    
    
    2.22
    
    
    2.49
 A summary of outstanding warrants as of December 31, 2004, the range of exercise prices,
the weighted-average exercise price, the weighted-average remaining contractual life, the amount of
warrants currently exercisable and the weighted-average exercise price of warrants currently
exercisable is as follows: Warrants Outstanding
    
    
    Warrants ExercisableNumber
    
    
    Weighted-Average
    
    
    Weighted-
    
    
    Number
    
    
    Weighted-Range of
    
    Outstanding
    
    
    Remaining
    
    
    Average
    
    
    Exercisable
    
    
    AverageExercise Prices
    
    at 12/31/04
    
    
    Contractual Life
    
    
    Exercise Price
    
    
    at 12/31/04
    
    
    Exercise Price$0.43  to $0.50
    
    
    517,470
    
    
    4.0 Years
    
    $
    0.43
    
    
    
    517,470
    
    
    $
    0.431.00 to 1.33
    
    
    707,500
    
    
    5.1
    
    
    
    
    1.12
    
    
    
    707,500
    
    
    
    1.122.05 to 2.64
    
    
    574,000
    
    
    4.4
    
    
    
    
    2.40
    
    
    
    574,000
    
    
    
    2.403.00 to 3.88
    
    
    255,000
    
    
    5.9
    
    
    
    
    3.56
    
    
    
    226,375
    
    
    
    3.625.00 to 5.15
    
    
    215,000
    
    
    5.3
    
    
    
    
    5.07
    
    
    
    215,000
    
    
    
    5.07$0.43 to $5.15
    
    
    2,268,970
    
    
    
    
    
    
    
    
    
    
    
    2,240,345
 c. Settlement of SAL Earn-out Obligations In August, 2004, holders of more than 99 percent of the SAL earn-out interests (see Note 3)
accepted the Companys offer to receive payment of $625,000 in common stock, valued at the average
of the closing prices of JMARs common stock for the five trading days during the
period August 18, 2004 to August 24, 2004 ($1.31). The
additional consideration of $625,000 is included in goodwill on the accompanying Consolidated Balance Sheet. d. Other Equity Transactions During 2004 and 2003, $1,254,500 and $1,173,000, respectively, of the Working Capital Line
(see Note 9) was converted into 1,048,913 and 1,275,000 shares, respectively, of common stock of
the Company. In February, 2003, under the Companys Shelf Registration Statement, the Company sold 100,000
shares of its common stock and a warrant for 20,000 shares, exercisable at $1.25 per share, for
gross proceeds of $100,000. 55




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) In March 2002, under the Shelf Registration Statement, the Company sold 1 million shares of
its common stock for gross proceeds of $2 million less offering costs of approximately $220,000. In
connection with this transaction, the Company issued to the purchasers warrants to purchase 150,000
shares of its common stock at an exercise price of $2.50 per share, expiring in March 2006. Also,
the Company paid a placement agent a fee of 6% of the gross proceeds, a $25,000 non-accountable
expense allowance and issued warrants to purchase 20,000 shares of the Companys common stock at an
exercise price of $2.40 per share. The warrants to purchase 170,000 shares of the Companys common
stock were valued at approximately $305,000 based on the Black Scholes pricing model. The warrants
were recorded in the accompanying consolidated financial statements as paid-in-capital with a
corresponding reduction in the amount assigned to the common stock issued. During the years ended December 31, 2004 and 2003, the Company received net proceeds of
$157,274 and $289,577, respectively, from the exercise of warrants and options into 71,933 and
144,068 shares of common stock, respectively. During 2004, 2003 and 2002, the Company issued 11,604, 11,026 and 11,632 shares of common
stock for services and other obligations. These issuances were valued based upon the fair market
value of the Companys common stock at the date of issue. 12. Stock-Based Compensation Plans The Company has six stock option plans, the 1991 Stock Option Plan (1991 Plan), the
1999 Stock Option Plan (1999 Plan), the Management Anti-Dilution Plan (Anti-Dilution Plan), an
incentive plan which provided for the issuance of options to JPSI employees (JPSI Plan) and two
incentive plans which provide for the issuance of options to Research Division
employees (Research Division Plans). The Company is also a party to non-plan option agreements with several individuals. The Company was authorized to grant options to its employees (including directors)
and consultants for up to 1,480,000 shares under the 1991 Plan, 1,900,000 shares under the 1999
Plan, 806,637 shares under the Anti-Dilution Plan, 450,000 shares under the JPSI Plan and 350,000
shares under the Research Division Plans (Plans). No further option grants are allowed except under
the 1999 Plan. As of December 31, 2004, the Company has granted 1,189,352 options under the 1991
Plan, 1,189,446 options under the 1999 Plan, 306,920 options under the Anti-Dilution Plan, 33,000
options under the JPSI Plan and 65,500 options under the Research Division Plans. In
addition, 560,000 non-qualified options have been granted to three employees outside of the above
plans. Except as noted in the next sentence, under all Plans the option exercise price was equal to or
more than the market price of JMARs common stock on date of grant in 2004, 2003 and 2002, and no compensation
expense was recognized. Options for a total of 7,500 shares were granted to the Companys directors
in payment of meeting fees in 2004, which had an exercise price of $1.00 below the market price
resulting in compensation
expense of $7,500. Options usually have a term of ten years and vest one-third per year after date
of grant. As of December 31, 2004, options to purchase 710,554 shares are available for grant
pursuant to the 1999 Plan. A summary of the status of the total number of employee stock options pursuant to all of the
above plans as of December 31, 2004, 2003 and 2002 and changes during the years then ended is
presented in the tables below: 56




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##### Table of Contents



JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) 2004
    
    
    2003
    
    
    2002Wtd Avg
    
    
    
    
    
    
    Wtd Avg
    
    
    
    
    
    
    Wtd AvgShares
    
    
    Ex Price
    
    
    Shares
    
    
    Ex Price
    
    
    Shares
    
    
    Ex PriceOutstanding at beg. of year
    
    
    3,028,247
    
    
    $
    2.43
    
    
    
    3,214,834
    
    
    $
    2.93
    
    
    
    2,436,802
    
    
    $
    3.53Granted
    
    
    263,500
    
    
    
    1.68
    
    
    
    489,500
    
    
    
    1.05
    
    
    
    898,800
    
    
    
    1.48Exercised
    
    
    (66,183
    )
    
    
    2.25
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Forfeited
    
    
    (297,726
    )
    
    
    3.34
    
    
    
    (676,087
    )
    
    
    3.50
    
    
    
    (120,768
    )
    
    
    4.04Outstanding at end of year
    
    
    2,927,838
    
    
    
    2.27
    
    
    
    3,028,247
    
    
    
    2.43
    
    
    
    3,214,834
    
    
    
    2.93Exercisable at end of year
    
    
    2,073,462
    
    
    
    
    
    
    
    1,945,969
    
    
    
    
    
    
    
    1,977,859Weighted average fair value
of options granted
    
    
    1.69
    
    
    
    
    
    
    
    0.92
    
    
    
    
    
    
    
    1.38
 A summary of the options outstanding as of December 31, 2004, the range of exercise
prices, the weighted-average exercise price, the weighted-average remaining contractual life, the
amount of options currently exercisable and the weighted-average exercise price of options
currently exercisable is as follows: Options Outstanding
    
    
    Options ExercisableNumber
    
    
    Weighted-Average
    
    
    Weighted-
    
    
    Number
    
    
    Weighted-Range of
    
    Outstanding
    
    
    Remaining
    
    
    Average
    
    
    Exercisable
    
    
    AverageExercise Prices
    
    at 12/31/04
    
    
    Contractual Life
    
    
    Exercise Price
    
    
    at 12/31/04
    
    
    Exercise Price$   0.53 to $0.90
    
    
    356,856
    
    
    
    7.7  years
    
    $
    0.87
    
    
    
    140,189
    
    
    $
    0.821.02 to   1.44
    
    
    875,200
    
    
    
    7.4
    
    
    
    1.31
    
    
    
    491,867
    
    
    
    1.281.56 to   2.44
    
    
    630,963
    
    
    
    5.5
    
    
    
    2.05
    
    
    
    427,967
    
    
    
    2.132.53 to   3.00
    
    
    603,545
    
    
    
    3.6
    
    
    
    2.90
    
    
    
    584,045
    
    
    
    2.903.13 to
  9.50
    
    
    461,274
    
    
    
    5.1
    
    
    
    4.66
    
    
    
    429,394
    
    
    
    4.77$   0.53 to $9.50
    
    
    2,927,838
    
    
    
    
    
    
    
    
    
    
    
    2,073,462
 13. Segment Information JMAR conducts its operations in the following four business segments: Research Division (formerly JMAR Research)  Located in San Diego, California, this
segment carries out contract research and development involving JMARs patented high brightness,
short-pulse, diode pumped solid state lasers (Britelight) and laser-produced plasma (LPP)
technology. A major portion of the Research Divisions R&D has been funded by contracts from DARPA
of the U.S. Department of Defense. This segments historic focus on X-ray lithography light source
R&D and equipment development was expanded in 2004 when it embarked on an effort to identify
additional uses for its laser and LPP technologies. As a result of this business expansion
investigation, this segment is developing several soft X-ray enabled products including a Compact
X-ray Microscope and a family of instruments for nanotechnology
applications. JMAR believes that this instrument family will provide the ability to carry out
chemical analysis, chemical vapor deposition, and machining at resolutions down to 20nm. During
2004, this segment accounted for approximately 35% of the Companys revenues. New products are developed at the Research Division based on contract and internally funded
R&D and then transitioned to JMARs Vermont Operations for product engineering and production. Vermont Operations (formerly JSAL) Located in South Burlington, Vermont, this segment
carries out contract research and development involving nanolithography and serves as JMARs
manufacturing arm, carrying out the manufacturing engineering, production, integration and test of
JMARs new products. The Vermont Operations also applies its program management, engineering and
manufacturing expertise to the contract development and production of new products using the
customers technology. As an example, the Vermont Operations is the design and manufacturing
contractor for FemtoTrace, Inc. building the READ 57




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) trace chemical sensors for real time detection of
extremely small quantities of organics. The READ equipment has uses in environmental contamination
detection and homeland security applications. The Vermont Operations will also introduce a novel
Optical Angular Scanning Imaging System (OASIS) for biological medical and materials research
applications in 2005. OASIS is a versatile, rapid scanning optical microscope that combines high
magnification, fine optical resolution, and rapid scanning motion control. This segment also
performs funded contract research and development for DARPA. During 2004, this segment accounted
for approximately 28% of the Companys revenues. Microelectronics Division (formerly JMAR Semiconductor)  This segment provides
process integration and maintenance support to the Defense Microelectronics Activitys
semiconductor fabrication facility in McClellan, California. It also designs and produces
application specific integrated circuits (ASICs) for military and commercial markets and is
developing application specific standard products. During 2004, this segment accounted for
approximately 37% of the Companys revenues. Sensor Products Group  This segments first product is the BioSentryTM, a
laser-based early-warning system that provides continuous, real-time surveillance, detection and
classification of waterborne microorganisms. Prospective applications include beverage bottling
quality assurance, water utility operations, cruise ship water monitoring and homeland security for
building water supply and water distribution systems. During 2004, there were no revenues from this
segment. Revenues are expected in 2005. The accounting policies of the reportable segments are the same as those described in Note 2.
The Company evaluates the performance of its operating segments primarily based on revenues and
operating income. Corporate costs are generally allocated to the segments. Segment information for the years ended December 31, 2004, 2003 and 2002 (excluding
discontinued operations) is as follows: 58




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) SensorResearch
    
    
    Vermont
    
    
    Microelectronics
    
    
    ProductsDivision
    
    
    Operations
    
    
    Division
    
    
    Group
    
    
    Corporate
    
    
    Total2004:Revenues
    
    $
    3,575,633
    
    
    $
    2,785,929
    
    
    $
    3,698,277
    
    
    $
    
    
    
    $
    
    
    
    $
    10,059,839Patent write-downs
    
    
    (191,575
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (191,575
    )Operating loss
    
    
    (1,306,568
    )
    
    
    (1,757,025
    )
    
    
    (600,759
    )
    
    
    (1,089,453
    )
    
    
    
    
    
    
    (4,753,805
    )Total assets
    
    
    3,239,951
    
    
    
    5,210,423
    
    
    
    1,895,020
    
    
    
    17,636
    
    
    
    7,063,068
    
    
    
    17,426,098Goodwill
    
    
    
    
    
    
    4,415,932
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,415,932Capital expend.
    
    
    15,920
    
    
    
    18,978
    
    
    
    160,845
    
    
    
    17,636
    
    
    
    194,659
    
    
    
    408,038Depreciation &
amortization
    
    
    163,314
    
    
    
    189,112
    
    
    
    50,337
    
    
    
    1,748
    
    
    
    609,060
    
    
    
    1,013,5712003:Revenues
    
    
    6,206,123
    
    
    
    6,561,372
    
    
    
    4,529,013
    
    
    
    
    
    
    
    
    
    
    
    17,296,508Patent & equip.
write-downs
    
    
    (346,060
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (346,060
    )Oper. income (loss)
    
    
    152,738
    
    
    
    (1,455,035
    )
    
    
    151,242
    
    
    
    
    
    
    
    (267,569
    )
    
    
    (1,418,624
    )Total assets
    
    
    3,119,115
    
    
    
    4,626,299
    
    
    
    1,708,504
    
    
    
    
    
    
    
    4,039,265
    
    
    
    13,493,183Goodwill
    
    
    
    
    
    
    3,790,907
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,790,907Capital expend.
    
    
    38,349
    
    
    
    13,449
    
    
    
    61,767
    
    
    
    
    
    
    
    9,828
    
    
    
    123,393Depreciation &
amortization
    
    
    226,995
    
    
    
    311,857
    
    
    
    24,427
    
    
    
    
    
    
    
    375,439
    
    
    
    938,7182002:Revenues
    
    
    6,951,114
    
    
    
    7,602,336
    
    
    
    3,830,360
    
    
    
    
    
    
    
    
    
    
    
    18,383,810Deferred comp.
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,074,324
    )
    
    
    (1,074,324
    )Oper. income (loss)
    
    
    228,963
    
    
    
    (1,498,007
    )
    
    
    268,018
    
    
    
    
    
    
    
    (2,108,828
    )
    
    
    (3,109,854
    )Total assets
    
    
    2,775,418
    
    
    
    5,897,912
    
    
    
    1,694,927
    
    
    
    
    
    
    
    3,403,645
    
    
    
    13,771,902Goodwill
    
    
    
    
    
    
    3,790,907
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,790,907Capital expend.
    
    
    311,890
    
    
    

    52,144
    
    
    
    28,021
    
    
    
    
    
    
    
    1,509
    
    
    
    393,564Depreciation &
amortization
    
    
    369,940
    
    
    
    307,614
    
    
    
    14,837
    
    
    
    
    
    
    
    84,926
    
    
    
    777,317
 The patent and equipment write-downs for 2003 of $346,060 includes $200,056 related to an
asset held by the Research Division that will not be used by the
Company in the future and $146,004
of patent costs. The deferred compensation for 2002 of $1,074,324 relates to the retirement
benefits recorded in August 2002 associated with the retirement of the Companys former Chairman
and Chief Executive Officer. Significant Customers Sales to the United States Government aggregated $5,386,526, $11,868,974 and $12,484,601 in
2004, 2003 and 2002, respectively. Accounts receivable from the United States Government at
December 31, 2004 and 2003 was $2,071,341 and $2,146,720, respectively. In addition, sales to
General Dynamics Advanced Information Systems (GDAIS) were $3,692,223, $2,712,770 and $4,306,801
in 2004, 2003 and 2002, respectively. Accounts receivable from GDAIS at December 31, 2004 and 2003
was $847,584 and $471,506, respectively. Export Sales For the years ended December 31, 2004, 2003 and 2002, all revenues were generated from
the United States and all assets of the Company are located in the United States. 59




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JMAR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont) 14. Quarterly Financial Information (Unaudited) The following is a summary of unaudited quarterly results for the years ended December 31,
2004 and 2003: Gain (Loss)
    
    
    Loss
    
    
    
    
    
    
    
    
    
    
    WeightedYear Ended
    
    
    
    
    
    
    
    
    
    from
    
    
    Applicable to
    
    
    Loss Per Share
    
    
    AverageDecember 31,
    
    
    
    
    
    Gross
    
    
    Discontinued
    
    
    Common
    
    
    Continuing
    
    
    Discontinued
    
    
    Shares2004
    
    Revenues
    
    
    Profit
    
    
    Operations
    
    
    Stock
    
    
    Operations
    
    
    Operations
    
    
    OutstandingDecember 31
    
    $
    1,755,289
    
    
    $
    448,626
    
    
    $
    (174,793
    )
    
    $
    (2,504,241
    )
    
    $
    (0.07
    )
    
    $
    (0.01
    )
    
    
    31,374,439September 30
    
    
    2,257,737
    
    
    
    214,819
    
    
    
    (52,549
    )
    
    
    (1,929,816
    )
    
    
    (0.06
    )
    
    
    
    
    
    
    31,088,814June 30
    
    
    3,011,437
    
    
    
    669,842
    
    
    
    74,546
    
    
    
    (1,322,001
    )
    
    
    (0.04
    )
    
    
    
    
    
    
    30,885,182March 31
    
    
    3,035,376
    
    
    
    665,453
    
    
    
    (62,097
    )
    
    
    (2,123,958
    )
    
    
    (0.07
    )
    
    
    
    
    
    
    29,660,437$
    10,059,839
    
    
    $
    1,998,740
    
    
    $
    (214,893
    )
    
    $
    (7,880,016
    )
    
    
    (0.25
    )
    
    
    (0.01
    )
    
    
    30,758,689
 Gain (Loss)
    
    
    Loss
    
    
    
    
    
    
    
    
    
    
    WeightedYear Ended
    
    
    
    
    
    
    
    
    
    from
    
    
    Applicable to
    
    
    Loss Per Share
    
    
    AverageDecember 31,
    
    
    
    
    
    Gross
    
    
    Discontinued
    
    
    Common
    
    
    Continuing
    
    
    Discontinued
    
    
    Shares2003
    
    Revenues
    
    
    Profit
    
    
    Operations
    
    
    Stock
    
    
    Operations
    
    
    Operations
    
    
    OutstandingDecember 31
    
    $
    3,570,210
    
    
    $
    1,098,602
    
    
    $
    8,741
    
    
    $
    (684,621
    )
    
    $
    (0.03
    )
    
    $
    
    
    
    
    26,992,354September 30
    
    
    3,964,930
    
    
    
    983,222
    
    
    
    (53,673
    )
    
    
    (1,063,451
    )
    
    
    (0.04
    )
    
    
    
    
    
    
    25,500,260June 30
    
    
    5,027,654
    
    
    
    971,819
    
    
    
    (686,830
    )
    
    
    (1,561,214
    )
    
    
    (0.03
    )
    
    
    (0.03
    )
    
    
    24,236,140March 31
    
    
    4,733,714
    
    
    
    910,984
    
    
    
    (459,987
    )
    
    
    (912,080
    )
    
    
    (0.02
    )
    
    
    (0.02
    )
    
    
    23,886,503$
    17,296,508
    
    
    $
    3,964,627
    
    
    $
    (1,191,749
    )
    
    $
    (4,221,366
    )
    
    
    (0.12
    )
    
    
    (0.04
    )
    
    
    25,618,296
 The Company continued to incur losses from discontinued operations in 2004 primarily
related to the lease of the Irvine facility. In 2003, the losses from discontinued operations
primarily related to the lease of the Irvine facility and legal costs for disputed liabilities of
that business, offset in part by gains from settlement of certain liabilities (see Note 9). 15. Intangible Assets The Company adopted SFAS No. 142 Goodwill and Other Intangible Assets (SFAS
142) effective January 1, 2002. In accordance with SFAS 142, the Company does not amortize
goodwill. The Companys goodwill of $4,415,932 and $3,790,907 at December 31, 2004 and 2003,
respectively, is related to the acquisition of SAL, Inc. in August, 2001. As of December 31, 2004
and 2003, the Company had the following amounts related to other intangible assets: December 31, 2004
    
    
    December 31, 2003Gross
    
    
    
    
    
    Net
    
    
    Gross
    
    
    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Intangible
    
    
    Carrying
    
    
    Accumulated
    

    
    IntangibleAmount
    
    
    Amortization
    
    
    Assets
    
    
    Amount
    
    
    Amortization
    
    
    AssetsPatents
    
    $
    908,032
    
    
    $
    489,174
    
    
    $
    418,858
    
    
    $
    953,124
    
    
    $
    421,583
    
    
    $
    531,541Unpatented Technology
    
    
    450,000
    
    
    
    450,000
    
    
    
    
    
    
    
    450,000
    
    
    
    362,500
    
    
    
    87,500License
    
    
    126,250
    
    
    
    7,917
    
    
    
    118,333
    
    
    
    65,000
    
    
    
    
    
    
    
    65,000$
    537,191
    
    
    
    
    
    
    
    
    
    
    $
    684,041
 During 2004, the Company spent $159,770 and $61,250 on patent cost and licenses,
respectively. The Research Division accounted for $158,413 of the patent costs and $21,250 of the
license costs, while the Microelectronics Division accounted for $1,357 of the patent costs and
$40,000 of the license costs. 60




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JMAR TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Cont) Aggregate amortization expense of the intangible assets with determinable
lives was $163,008, $282,055 and $379,205 for the years ended December 31, 2004, 2003 and 2002, respectively. The
unamortized balance of intangible assets is estimated to be amortized as follows: For the Year Ending
    
    Estimated AmortizationDecember 31,
    
    Expense2005
    
    $
    17,8402006
    
    
    62,0642007
    
    
    62,0642008
    
    
    62,0642009
    
    
    62,064Beyond
    
    
    271,095$
    537,191
 16. Subsequent Events (Unaudited) On February 1, 2005, the Company entered into a Securities
Purchase Agreement and completed the sale of $4 million of the Companys Common Stock and Warrants
to five institutional investors (Investors). Pursuant to the Securities Purchase Agreement, the
Company issued a total of 3,225,807 shares of Common Stock at $1.24 per share and Warrants to
purchase 1,209,679 shares of Common Stock to the Investors. The Warrants have an exercise price of
$1.73 per share and a term of five years. After expenses of the transaction and the advisors fee,
the Company received approximately $3,852,000. In addition, on February 1, 2005, the Company
entered into agreements with Laurus to amend the Companys Series E, F, G and H Convertible
Preferred Stock (Amendment) (see Note 11). As a result of the Amendment in February 2005, the
Company will record an additional discount representing the difference between the fair value of
the Preferred Stock immediately prior to and after the Amendment, which management has estimated to
be approximately $1.1 million valued based on the Black Scholes pricing model using the following
assumptions: risk-free interest rate of 3.23 percent based on
estimated yields of 2-year U.S. Treasury Securities; expected
dividend yield of 0 percent; remaining contractual life of 2 years; and expected volatility of 108 percent.
The volatility is based on JMARs historical stock prices for the
past two years, consistent with the remaining contractual life of the
preferred stock. This amount will be recorded during the
first quarter of fiscal year 2005 as a reduction of preferred stock and amortized to preferred
stock dividends over the earlier of the redemption payment period or the conversion dates (see Note
11). In February 2005, DARPA released the remaining $3,508,000 in funds related to the Companys
DARPA Contract. 61




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##### Table of Contents



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 TECHNOLOGIES, INC.Date: March 30, 2005
    
    By:
    
    /s/ Ronald A. WalrodChief Executive Officer
 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. Signature
    
    Title
    
    Date/s/ Vernon H. Blackman
    
    Chairman of the Board
    
    March 30, 2005Vernon H. Blackman/s/ Ronald A. Walrod
    
    Chief Executive Officer and
    
    March 30, 2005DirectorRonald A. Walrod/s/ Dennis E. Valentine
    
    Chief Financial Officer
    
    March 30, 2005and Chief Accounting OfficerDennis E. Valentine/s/ C. Neil Beer
    
    Director
    
    March 30, 2005C. Neil Beer/s/ Charles A. Dickinson
    
    Director
    
    March 30, 2005Charles A. Dickinson/s/ John S. Martinez
    
    Director
    
    March 30, 2005John S. Martinez/s/ Edward P. OSullivan II
    
    Director
    
    March 30, 2005Edward P. OSullivan II/s/ Barry Ressler
    
    Director
    
    March 30, 2005Barry Ressler
 62




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##### Table of Contents



Index to Exhibits ExhibitNo.
    
    Description2.1(16)
    
    Agreement of Purchase and Sale of Stock, dated July 18, 2003, between the Company, JMAR
Precision Systems, Inc., Chandu Vanjani and Veena Kaul.3.1 (1)(2)
    
    Certificate of Incorporation and amendments thereto.3.2 (4)
    
    Amendments to Certificate of Incorporation, filed on July 9, 1992, December 11, 1992,
January 11, 1993 and February 1, 1993.3.3 (5)
    
    Amendment to Certificate of Incorporation, filed on August 23, 1994.3.4 (7)
    
    Certificate of Ownership and Merger, filed on May 27, 1998.3.5 (21)
    
    Amendment to Certificate of Incorporation, filed on November 15, 2004.3.6 (1)
    
    Bylaws and amendments thereto.3.7 (9)
    
    Amendment to Bylaws adopted June 25, 2000.4.1 (3)
    
    Form of Common Stock Certificate.4.2 (8)
    
    Rights Agreement, dated as of February 12, 1999 between the Company and American
Securities Trust & Transfer, Inc., including the Certificate of Designations, the form of
Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B and C,
respectively.4.3 (14)
    
    Form of Stock Option Agreement between the Company and the employees listed on attached
schedule. (+)4.4 (14)
    
    Stock Option Agreement, dated October 14, 2002, between the Company and Ronald A.
Walrod. (+)4.5 (13)
    
    Common Stock Purchase Warrant for 300,000 shares dated March 14, 2003 issued to Laurus
Master Fund, Ltd (Laurus) in connection with the issuance of Series A Preferred Stock and
Series B Preferred Stock.4.6 (14)
    
    Convertible Note dated March 21, 2003 executed by the Company in favor of Laurus
evidencing receivablesbased line of credit for up to $3 million.4.7 (14)
    
    Common Stock Purchase Warrant for 400,000 shares dated March 21, 2003 issued to Laurus
in connection with $3 million receivables financing facility.4.8 (15)
    
    Amendment, dated April 28, 2003, between Laurus Master Fund, Ltd. and the Company.4.9 (17)
    
    Common Stock Purchase Warrant for 150,000 shares dated September 30, 2003 issued to
Laurus in connection with the issuance of Series C Preferred Stock.4.10 (18)
    
    Certificate to set forth Designations, Voting Powers, Preferences, Limitations,
Restrictions and Relative Rights of Series D 8% Convertible Preferred Stock, $0.01 Par Value
Per Share.4.11 (18)
    
    Certificate to set forth Designations, Voting Powers, Preferences, Limitations,
Restrictions and Relative Rights of Series E 8% Convertible Preferred Stock, $0.01 Par Value
Per Share.
 63




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ExhibitNo.
    
    Description4.12 (19)
    
    Certificate to set forth Designations, Voting Powers, Preferences, Limitations,
Restrictions and Relative Rights of Series F Convertible Preferred Stock, $0.01 Par Value Per
Share.4.13 (19)
    
    Certificate to set forth Designations, Voting Powers, Preferences, Limitations,
Restrictions and Relative Rights of Series G Convertible Preferred Stock, $0.01 Par Value Per
Share.4.14 (19)
    
    Certificate to set forth Designations, Voting Powers, Preferences, Limitations,
Restrictions and Relative Rights of Series H Convertible Preferred Stock, $0.01 Par Value Per
Share.4.15 (18)
    
    Common Stock Purchase Warrant for 200,000 shares dated December 17, 2003 issued to
Laurus in connection with the issuance of Series D Preferred Stock.4.16 (18)
    
    Common Stock Purchase Warrant for 90,000 shares dated January 7, 2004 issued to Laurus
in connection with the issuance of Series E Preferred Stock.4.17 (18)
    
    Common Stock Purchase Warrant for 100,000 shares dated January 7, 2004 issued to Laurus
in connection with the amendment of the Convertible Notes.4.18 (19)
    
    Common Stock Purchase Warrant for 50,000 shares dated February 5, 2004 issued to Laurus
in connection with the issuance of Series F Preferred Stock.4.19 (19)
    
    Common Stock Purchase Warrant for 50,000 shares dated February 5, 2004 issued to Laurus
in connection with the issuance of Series G Preferred Stock.4.20 (19)
    
    Common Stock Purchase Warrant for 100,000 shares dated February 5, 2004 issued to Laurus
in connection with the issuance of Series H Preferred Stock.4.21(23)
    
    Form of Warrant, dated as of January 25, 2005, issued to the assignees of PointSource
Technologies, LLC.4.22(22)
    
    Form of Warrant, dated February 1, 2005, issued to Portside Growth & Opportunity Fund,
Smithfield Fiduciary LLC, Bluegrass Growth Fund, LP, Bluegrass Growth Fund, Ltd., and Laurus
Master Fund, Ltd.4.23(23)
    
    Form of Warrant issued to affiliates of Source Capital Group, Inc.10.1 (6)
    
    The Companys 1991 Stock Option Plan, as amended. (+)10.2 (12)
    
    The Companys 1999 Stock Option Plan, as amended. (+)10.3 (11)
    
    Agreement dated September 16, 2002 between the Company and John S. Martinez. (+)10.4 (10)
    
    Employment Agreement between the Company and Ronald A. Walrod, dated October 14, 2002.
(+)10.5 (14)
    
    Purchase and Security Agreement dated March 21, 2003 between the Company, JMAR Research,
Inc., JMAR/SAL NanoLithography, Inc., JSI Microelectronics, Inc. and JMAR Precision Systems,
Inc., and Laurus Master Fund, Ltd.10.6 (16)
    
    Secured Promissory Note, dated July 18, 2003, executed by Chandu Vanjani in favor of the
Company in the principal amount of $150,000.10.7 (16)
    
    Secured Promissory Note, dated July 18, 2003, executed by Veena Kaul in favor of the
Company in the principal amount of $100,000.
 64




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##### Table of Contents



ExhibitNo.
    
    Description10.8(24)
    
    JMAR Balanced Scorecard Performance Based Compensation Plan, as amended. (+)10.9
    
    Form of Indemnification Agreement entered into between the Company and each of the members of
its Board of Directors.(+)10.10
    
    Form of Indemnification Agreement entered into between the Company and each of its executive
officers.(+)10.11(23)
    
    Securities Purchase Agreement, dated as of January 25, 2005, between the Company and
PointSource Technologies, LLC, related to entry into License Agreement.10.12
    
    Patent and Technology License Agreement, dated January 25, 2005, between PointSource
Technologies, LLC and the Company.10.13(23)
    
    Registration Rights Agreement, dated as of January 25, 2005, between the Company and
PointSource Technologies, LLC.10.14(22)
    
    Securities Purchase Agreement, dated February 1, 2005, among the Company and Portside
Growth & Opportunity Fund, Smithfield Fiduciary LLC, Bluegrass Growth Fund, LP, Bluegrass
Growth Fund, Ltd., and Laurus Master Fund, Ltd. related to a $4 million financing.10.15(22)
    
    Registration Rights Agreement, dated February 1, 2005, among the Company and Portside
Growth & Opportunity Fund, Smithfield Fiduciary LLC, Bluegrass Growth Fund, LP, Bluegrass
Growth Fund, Ltd., and Laurus Master Fund, Ltd.10.16(22)
    
    Amendments to Certificates of Designations of Series E, F, G and H Convertible Preferred
Stock, each dated February 1, 2005, between the Company and Laurus Master Fund, Ltd.10.17(25)
    
    Technology Transfer and License Agreement, dated February 21, 2005, between JMAR
Technologies, Inc. and Gregory Quist and David Drake doing business as The LXT Group.10.18(25)
    
    Consulting Agreement for Technical and Other Services, effective as of January 31, 2005
(but executed on February 21, 2005), between JMAR Technologies, Inc. and The LXT Group.10.19
    
    Technology Transfer and Contingent Purchase Agreement, dated March 4, 2005, between the
Company and Olivenhain Municipal Water District.10.20
    
    Agreement, dated March 18,
2003, between the Company and FemtoTrace, Inc.10.21
    
    Purchase Orders, dated
March 2, 2004, March 2, 2004, January 11, 2005 and
March 14, 2005, issued by General Dynamics Advanced Information
Services.10.22
    
    Order for Supply and Services,
dated September 23, 2004, issued by Naval Air Warfare Center AD
(PAX).10.23
    
    Amendment to
Solicitation/Modification of Contract, effective February 11,
2005, issued by U.S. Army RDECOM Acquisition Center.14.1(20)
    
    Code of Business Conduct and Ethics for all employees and directors.14.2(20)
    
    Code of Ethics for CEO, General Managers and Senior Financial Officers.21.1
    
    Subsidiaries of the Company include JMAR Research, Inc. (a California corporation), JSI
Microelectronics, Inc. (a California corporation) and JMAR/SAL NanoLithography, Inc. (a
California corporation).23.1
    
    Consent of Independent Registered Public Accounting Firm.31.1
    
    Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
   (+)
    
    These contracts are management compensation contracts required to be separately identified
pursuant to Item 15 (a) of Form 10-K. 65




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##### Table of Contents



(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 Form 10-K for the year
ended December 31, 1991.(3)
    
    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.(4)
    
    Incorporated by reference to the exhibit filed with the Companys Form 10-K for the year
ended December 31, 1993.(5)
    
    Incorporated by reference to the exhibit filed with the Companys Form 10-K for the year
ended December 31, 1994.(6)
    
    Incorporated by reference to the exhibit filed with the Companys Proxy Statement for the
1996 Annual Meeting of Shareholders.(7)
    
    Incorporated by reference to the exhibit filed with the Companys Form 8-K filed June 17,
1998.(8)
    
    Incorporated by reference to the exhibit filed with the Companys Form 8-A filed March 8,
1999.(9)
    
    Incorporated by reference to the exhibit filed with the Companys Form 10-Q for the quarter
ended June 30, 2000.(10)
    
    Incorporated by reference to the exhibit filed with the Companys Form 8-K filed October 15,
2002.(11)
    
    Incorporated by reference to the exhibit filed with the Companys Form 10-Q for the quarter
ended September 30, 2002.(12)
    
    Incorporated by reference to the exhibit filed with the Companys Proxy Statement for the
2002 Annual Meeting of Shareholders.(13)
    
    Incorporated by reference to the exhibit filed with the Companys Form 8-K filed March 17,
2003.(14)
    
    Incorporated by reference to the exhibit filed with the Companys Form 10-K for the year
ended December 31, 2002.(15)
    
    Incorporated by reference to the exhibit filed with the Companys Form 8-K filed May 1, 2003.(16)
    
    Incorporated by reference to the exhibit filed with the Companys Form 8-K filed July 31,
2003.(17)
    
    Incorporated by reference to the exhibit filed with the Companys Form S-3 filed November 5,
2003.(18)
    
    Incorporated by reference to the exhibit filed with the Companys Form S-3 filed January 16,
2004.(19)
    
    Incorporated by reference to the exhibit filed with the Companys Form S-3 filed February 9,
2004.(20)
    
    Incorporated by reference to the exhibit filed with the Companys Form 10-K for the year
ended December 31, 2003.(21)
    
    Incorporated by reference to the exhibit filed with the Companys Form 10-Q for the quarter
ended September 30, 2004.(22)
    
    Incorporated by reference to the exhibit filed with the Companys Form 8-K filed February 7,
2005.(23)
    
    Incorporated by reference to the exhibit filed with the Companys Form S-3 filed February 9,
2005.(24)
    
    Incorporated by reference to the exhibit filed with the Companys Form 8-K filed February 18,
2005.(25)
    
    Incorporated by reference to the exhibit filed
with the Companys Form 8-K filed February 25,
2005. 66




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##### Table of Contents



Schedule II JMAR TECHNOLOGIES, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 AdditionsCharged toBalance at
    
    
    Costs and
    
    
    
    
    
    
    
    
    
    
    Balance atDescription
    
    Beginning of Year
    
    
    Expenses
    
    
    Other
    
    
    Deductions
    
    
    End of YearFor the year ended December 31, 2004:Warranty reserve
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Reserve for inventory excess and obsolescence
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Allowance for doubtful accounts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    For the year ended December 31, 2003:Warranty reserve
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Reserve for inventory excess and obsolescence
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Allowance for doubtful accounts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    For the year ended December 31, 2002:Warranty reserve
    
    $
    115,233
    
    
    $
    41,299
    
    
    $
    (156,532
    )
    
    $
    
    
    
    $
    Reserve for inventory excess and obsolescence (A)
    
    
    2,115,143
    
    
    
    300,000
    
    
    
    (2,415,143
    )
    
    
    
    
    
    
    Allowance for doubtful accounts
    
    
    27,812
    
    
    
    
    
    
    
    (27,812

    )
    
    
    
    
    
    
    
   (A)
    
    This reserve relates to inventory of JPSI, which is classified as discontinued operations
in 2002. 67