The fair value of each option and warrant grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: risk-free interest rate of approximately 2.74 percent (4 percent in 2002); expected dividend yields of 0 percent; expected lives of 6 years and expected volatility of 142 percent.

     The Company was authorized to grant options or warrants to its employees (including directors) and consultants for up to 1,480,000 shares under the 1991 Plan, 1,900,000 shares under the 1999 Plan, 806,637 shares under the Anti-Dilution Plan, 350,000 shares under the Research Division Plans, 550,000 shares under the JPSI Plans and 25,000 shares under the Microelectronics Division Plan (the “Plans”). The options granted under the JPSI Plans expire 60 days after termination of employment, therefore, effective as of September 16, 2003 all but 53,000 warrants under the JPSI Plans will have expired unless exercised due to the sale of JPSI and termination of JPSI employees. Under all Plans, the option or warrant exercise price is equal to or more than the stock’s market price on date of grant. During the quarter ended June 30, 2003, 355,000 options were granted pursuant to the 1999 Plan.

(4)  Inventories

     Inventories are carried at the lower of cost on the first-in, first-out basis or market and are comprised of materials, direct labor and applicable manufacturing overhead. At June 30, 2003 and December 31, 2002, inventories consisted of the following:

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

(5)  Property and Equipment

     At June 30, 2003 and December 31, 2002, property and equipment consisted of the following:

(6)  Segment Information

     In the first quarter of 2002, the Company decided to discontinue and sell its standard semiconductor products business and shift more of its resources to accelerate the market entry of its CPL products. JMAR’s standard semiconductor products business initiative involved the design, manufacture and introduction of new standard product semiconductor chips. With the severe downturn in the worldwide semiconductor market beginning in 2000 and continuing into 2002, the Company had little success in selling its new standard product chips. The Company determined that substantial additional capital would have been required for these new chips to become established in what became an over-supplied chip market, as well as to develop newer, higher value chips. The Company concluded that it would not continue to invest its resources in this business.

     In furtherance of its efforts to focus its resources on its CPL business, during the later half of 2002, the Company concluded that the precision equipment business did not fit with the strategic direction of the Company’s CPL business area and that the markets for that segments’ products would continue to be slow in the near term. Therefore, in December, 2002, the Company decided to initiate the process of selling this business.

     As a result of these decisions, and to streamline the Company’s operations and better support the commercialization of its emerging CPL semiconductor manufacturing systems and related technologies, the Company now operates in three business segments, as follows:

     Research Division (formerly JMAR Research) – This segment’s role is as an innovator of laser and laser-produced plasma technologies for the Company’s CPL Source, EUV generators, and related products such as high-brightness lasers. During the six months ended June 30, 2003 and 2002, this segment accounted for approximately 31% and 26%, respectively, of the Company’s revenues.

     Systems Division (formerly JMAR/SAL NanoLithography) – This segment encompasses the development of X-ray lithography steppers, and the product engineering, production and integration of CPL light sources and complete CPL stepper systems. During the six months ended June 30, 2003 and 2002, this segment accounted for approximately 42% and 59%, respectively, of the Company’s revenues.

     Microelectronics Division – In 2002, JMAR discontinued the standard products business and the assets of its Sacramento operations were sold to JSI Microelectronics, Inc., a wholly-owned subsidiary of the Company, now the Microelectronics Division. This segment provides process integration and maintenance support for the Defense Microelectronics Activity semiconductor fabrication facility in Sacramento, California, and ASIC design and production capability for the military and commercial markets. During the six months ended June 30, 2003 and 2002, this segment accounted for approximately 27% and 15%, respectively, of the Company’s revenues.

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

     The accounting policies of the reportable segments are the same as those described in Note 2 of the Company’s Form 10-K for the year ended December 31, 2002. The Company evaluates the performance of its operating segments primarily based on revenues and operating income. Corporate costs are generally allocated to the segments.

     Segment information for the three and six months ended June 30, 2003 and 2002 (excluding discontinued operations) is as follows (2002 has been restated to reflect the new business segments):

     The asset writedown of $200,056 relates to an asset held by the Research Division that will not be used by the Company in the future.

     Sales to the United States Government aggregated $3,499,673, $5,925,018, $3,325,692 and $5,939,232 for the three and six months ended June 30, 2003 and 2002, respectively. In addition, sales to General Dynamics Advanced Information Systems were $1,058,881, $2,556,107, $588,613 and $1,000,696 for the three and six months ended June 30, 2003 and 2002, respectively.

(7)  Comprehensive Loss

     The other comprehensive loss for the six months ended June 30, 2002 represents the Company’s investment in Bede plc (“Bede”). In January 2002, the Company sold its remaining 545,500 shares of its investment in Bede for net proceeds of approximately $1.4 million. The gain from that transaction of $1,349,721 is included in this Consolidated Statement of Operations for the six months ended June 30, 2002. For the three and six months ended June 30, 2003, the Company did not have any elements of comprehensive income or loss, and therefore, there was no difference in the Company’s net loss and comprehensive loss for that period. For the six months ended June 30, 2002, the Company had an additional unrealized loss on marketable securities of $75,143 for the period from January 1, 2002 to the sale date of the securities, however, that loss was realized as a result of the sale of the securities.

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

(8)  Discontinued Operations/Assets Held for Sale

     The loss from operations of discontinued operations of $686,830 and $1,146,817 for the three and six months ended June 30, 2003 includes $270,761 and $311,977, respectively, related to the standard semiconductor products business and $416,069 and $834,840, respectively, related to the precision equipment business. In July 2003, the Company sold JPSI to several private investors (see Note 14). In accordance with SFAS No. 144, the results of operations of the precision equipment business for 2003 through the sale date are reported in discontinued operations.

     In September 2000, JSI moved into a significantly larger facility in anticipation of realizing its growth plans. Prior to December 31, 2001, the Company decided to take action to sublease the facility and move JSI into a smaller facility. The Company does not yet have a subtenant for this facility and, as of June 30, 2003, the Company has approximately $433,000 accrued for estimated future losses under this lease including $150,000 accrued in the quarter ended June 30, 2003. The lease provides for rent and related expenses of approximately $36,000 per month through August 2005. If the Company is unsuccessful in obtaining a subtenant on acceptable terms, there could be further losses related to that lease.

     At June 30, 2003 and December 31, 2002, net assets and liabilities of assets held for sale consisted of the following:

(9)  Line of Credit

     In March 2003, the Company entered into a $3 million Revolving Fixed Price Convertible 3 Year Note (the “Working Capital Line”) with Laurus Master Fund (“Laurus”) replacing its previous bank credit agreement, which required a compensating balance of $1.5 million at December 31, 2002. Advances under the Working Capital Line are up to 85% of eligible accounts receivable of the Company. The Company can convert a portion of the principal outstanding under the Working Capital Line to common stock at $.92 per share (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. Laurus can convert any portion of the principal outstanding to common stock at the Conversion Price any time the market price of the Company’s common stock is in

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

excess of the Conversion Price. After the first $2 million of conversions into common stock, the Conversion Price will be adjusted upward. The interest rate on the Working Capital Line is prime (4 percent at June 30, 2003) plus .75 percent, subject to a floor of 5 percent. The Working Capital Line requires that the Company’s quick ratio be .90 or higher. The Company’s quick ratio was .80 at June 30, 2003. Quick ratio is defined as the sum of cash and accounts receivable divided by the sum of current liabilities exclusive of current liabilities of assets held for sale. The Company has received a waiver from Laurus waiving compliance of this covenant during the period from June 30, 2003 to October 1, 2003. The amount outstanding at June 30, 2003 under the Working Capital Line was $2.2 million.

(10)  Equity Transactions

     In February 2003, under its Universal Blank Shelf Registration Statement, the Company sold 100,000 shares of its common stock for gross proceeds of $100,000. In connection with this transaction, the Company issued to the purchaser warrants to purchase 20,000 shares of its common stock at an exercise price of $1.25 per share.

     In March 2003, the Company also sold for cash, under its Universal Blank Shelf Registration Statement, $1 million of 8 percent Series A Convertible Preferred Stock (“Series A Preferred”) to Laurus at a fixed conversion price of $.88 per share. The Series A Preferred is redeemable in two years, if not previously converted. Except for the conversion price, the conversion terms of the Series A Preferred are the same as the conversion terms of the Working Capital Line. The proceeds received under the Series A Preferred were initially restricted, however, the funds are released as the Preferred Stock is converted to common stock. As of June 30, 2003, restricted cash was $668,416. During the three and six months ended June 30, 2003, Laurus converted $327,448 of the Series A Preferred into 372,100 shares of common stock of the Company. An additional $162,800 of Series A Preferred was converted in July 2003.

     In addition, in March, 2003, the Company sold for cash, under its Universal Blank Shelf Registration Statement, $1 million of 3 percent Series B Convertible Preferred Stock (“Series B Preferred”) to Laurus at a fixed conversion price of $.88 per share. The Series B Preferred is redeemable in cash or stock (if the closing market price of the Company’s common stock is 118% of the Conversion Price or higher for the 11 trading days prior to the redemption date) in twelve equal monthly installments starting October 1, 2003, if not previously converted. Conversions to equity are offset against the required principal repayments and, as a result of conversions to date, the first installment payment is scheduled for May, 2004. Except for the conversion price, the conversion terms of the Series B Preferred are the same as the conversion terms of the Working Capital Line. In the six months ended June 30, 2003, Laurus converted $339,944 of the Series B Preferred into 386,300 shares of common stock of the Company. An additional $288,640 of Series B Preferred was converted in July 2003.

     In connection with all of the above financing transactions with Laurus, the Company issued to Laurus warrants to purchase 550,000 shares of common stock at prices ranging from $1.058 to $1.33. In addition, Laurus will be issued a warrant to purchase one share of common stock for every $20 of principal under the Working Capital Line converted to equity, up to a total of 150,000 shares, at an exercise price of $1.15 per share. The Company valued all of these warrants using the Black-Scholes model and recorded the fair value of $374,000 as a discount to the convertible debt and preferred stock. As a result of the convertible securities issued to Laurus described above, the Company recorded an additional discount of $444,000 representing the intrinsic value of the beneficial conversion feature for the convertible debt and preferred stock, which will be amortized over the redemption period of the preferred stock and the life of the debt using the effective interest method. Included in the loss applicable to common stock in the Statement of Operations for the six months ended June 30, 2003 is preferred stock dividends of $229,453 which represents $27,604 of dividends paid in cash and $201,849 related to the beneficial conversion feature. Included in interest expense for the six months ended June 30, 2003 is $7,109 related to the beneficial conversion feature attributable to the convertible debt. In addition, there will be an additional beneficial conversion feature in the amount of $32,000 recorded as additional borrowings are made against the Working Capital Line and an additional beneficial conversion charge of $94,000 will be recorded prorata upon conversion of the convertible debt for the warrants issued thereon. In connection with the Preferred Stock issuances, the Company paid Laurus fees of $109,000 and incurred other costs of approximately $33,000.

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

(11)  Earnings (Loss) 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 net loss by the weighted average number of shares of common stock outstanding during the period. For the three and six months ended June 30, 2003 and 2002, the denominator in the diluted net 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 and shares underlying convertible debt and preferred stock. As of June 30, 2003 and 2002, the Company had outstanding warrants, stock options and shares underlying convertible debt and preferred stock of 9,256,312 and 4,000,043, respectively, all of which are antidilutive and were excluded from the computation of diluted loss per share. For the six months ended June 30, 2002, the diluted income from continuing operations was computed by dividing the income from continuing operations by the sum of the weighted average number of shares of common stock (23,103,559) plus dilutive employee stock options and warrants (894,790).

(12)  Intangible Assets

     The Company adopted Financial Accounting Standards Board No. 142 “Goodwill and Other Intangible Assets” (“FASB 142”) effective January 1, 2002. In accordance with FASB 142, the Company does not amortize goodwill. The Company’s goodwill of $3,790,907 at June 30, 2003 and December 31, 2002 is related to the Systems Division, acquired in August 2001. As of June 30, 2003, the Company had the following amounts related to other intangible assets:

     Aggregate amortization expense of the intangible assets with determinable lives was $69,816 and $139,593 for the three and six months ended June 30, 2003, respectively. The unamortized balance of intangible assets is estimated to be amortized as follows:

(13)  Legal Proceeding

     Following the discontinuance of the standard semiconductor products business of JMAR Semiconductor, Inc. (“JSI”) in the first quarter of 2002, JSI sought to negotiate debt reductions from the creditors associated with the discontinued portion of its business. JSI was a party to a Distributor Agreement with All American Semiconductor, Inc. (“All American”) under which All American had purchased approximately $700,000 of JSI chips for resale to customers. The Company reflected the proceeds as deferred revenue (a liability) and not as revenue pending sale to the ultimate customer. Under the terms of the Distributor Agreement, if All American properly terminated the Distributor Agreement, it had the right to

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

require JSI to repurchase those chips for the $700,000 paid by All American. Soon after the announcement by JMAR that JSI had discontinued its standard chip business, All American gave notice of termination of the Distributor Agreement and returned the chips it held, creating an obligation on JSI’s part to repay approximately $700,000 to All American. The $700,000 claim of All American is included in the total of approximately $2.2 million of current liabilities of assets held for sale that are included on JMAR’s Consolidated Balance Sheet at June 30, 2003 (see Note 8).

     In September, 2002, a Complaint was filed by All American against JSI and JMAR in San Diego Superior Court. The Complaint alleges that JSI owes All American approximately $700,000. The Complaint also alleges that All American was induced to refrain from terminating the agreement until after the JSI business had been discontinued. All American claims that such actions constituted fraud and that it is entitled to treble (triple) damages. All American has also alleged that JMAR is the “alter ego” of JSI and based on that theory should be held responsible for the obligations of JSI. While recognizing that the approximately $700,000 in indebtedness may be owed by JSI to All American under the agreement, JSI asserts that the obligations are merely of a contractual nature and strongly disputes that any of the actions taken constitute fraud. JMAR also disputes that it is the “alter ego” of JSI in light of the facts that JSI is a separately incorporated entity that has been more than adequately capitalized over its years of operations and, that JSI, and not JMAR, was the party to the Distributor Agreement and was the sole direct contact with All American. JMAR believes that there is insufficient evidence to support the alter ego theory and believes that it will ultimately prevail on this issue. JMAR and JSI are vigorously contesting any claims by All American that it is owed more than $700,000. In May, 2003, All American amended its Complaint to add JSI Microelectronics, Inc. (“JME”) as a defendant. In July, 2003 the defendants’ Demurrer was granted with the Court allowing All American to refile an Amended Complaint. Because JMAR, JME and JSI believe the All American Complaint remains defective and does not state valid claims, JMAR, JSI and JME have recently filed another Demurrer and Motion to Strike. The parties have engaged in a Mediation process in an attempt to settle this action, but there are no assurances this matter will settle prior to trial.

     After unsuccessfully engaging in efforts to sell the standard chip portion of JSI, in the fourth quarter of 2002, JSI transferred all of its assets and liabilities to a third party fiduciary in an assignment for the benefit of creditors. Under this state law procedure, the assignee liquidated the JSI assets and the proceeds from the sale of those assets will be equitably distributed among the creditors of JSI and the claims of creditors of JSI are limited to those proceeds. Following the assignment of those assets, the fiduciary sold those assets to JSI Microelectronics, Inc., a wholly-owned subsidiary of the Company, at a price equal to a 10% premium over an independently appraised value of those assets, with the purchase price consisting of cash, assumption of certain trade debt owed to suppliers who are critical to the ongoing operations and the waiver of any claims on debt owed by JSI to the Company. The Company has accounted for this transaction by recording the purchase of the assets at the lower of cost or fair value and the remaining amount of the liabilities owed to the unsecured creditors by JSI are reflected in net current liabilities of assets held for sale in the accompanying Consolidated Balance Sheet.

(14)  Subsequent Event

     In July 2003, the Company sold JPSI to several private investors. Under the terms of the sale, JMAR received $500,000 in a combination of cash and non-interest bearing promissory notes, and the buyer assumed 14 of the remaining 25 months of JPSI’s facility lease. The notes are secured by the assets of JPSI and the lease obligation is secured by personal property of the buyers. In addition, all JPSI receivables as of the closing were assigned to JMAR and JMAR agreed to pay all trade and employee related liabilities existing as of the closing and unknown liabilities, if any. The buyers have assumed all other ongoing commitments of JPSI. In accordance with SFAS No. 144, the results of operations of the precision equipment business for 2003 through the sale date are reported in discontinued operations.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

     JMAR Technologies, Inc. is a developer of collimated laser plasma lithography (CPL™) sources and stepper systems for the making of advanced semiconductor chips. These systems are based on the Company’s proprietary and patented solid state laser systems and its expertise in laser plasma-generated x-rays. The development of the Company’s CPL source and stepper systems has been principally funded by the U.S. Defense Advanced Research Projects Agency (DARPA). The strategy of the Company’s CPL business is to initially sell advanced lithography systems to manufacturers of Gallium Arsenide-based semiconductors (which are used in high performance electronics required for military systems and the growing commercial market for high speed communications applications). With planned investments from strategic partners and other sources, the Company’s goal is to introduce higher throughput lithography systems to the multi-billion dollar silicon-based semiconductor manufacturing industry in a timeframe sooner than competing Next Generation Lithography technologies, such as Extreme Ultraviolet technologies.

     The Company also provides semiconductor process integration services under contracts that support the Department of Defense’s mission to ensure a supply of semiconductor products for military systems.

     Through December 31, 2001, the Company operated in three segments as follows: Front-end Semiconductor Equipment and Services, Precision Equipment, and Semiconductor Products and Processes. In the first quarter of 2002, the Company decided to discontinue its standard semiconductor products business and shift more of its resources to accelerate the market entry of its CPL products. The standard semiconductor products portion of JMAR’s business had been a developmental effort, involving the design, manufacture and introduction of new standard product semiconductor chips. With the severe downturn in the worldwide semiconductor market beginning in 2000 and continuing into 2002, the Company had little success in selling its new standard product chips. The Company determined that substantial additional capital would have been required for these new chips to become established in what became an over-supplied chip market, as well as to develop newer, higher value chips. The Company concluded that it would not continue to invest its resources in this business.

     In furtherance of its efforts to focus its resources on its CPL business, the Company concluded during the latter half of 2002 that the precision equipment business did not fit with the strategic direction of the Company’s CPL business area and that the markets for that segment’s products would continue to be slow in the near term. Therefore, in December, 2002, the Company decided to initiate the process of selling that business and, in July 2003, the Company completed the sale of this business.

     The standard semiconductor products business and the precision equipment business have been accounted for in the accompanying consolidated financial statements as discontinued operations and the statement of operations for the three and six months ending June 30, 2002 has been restated to reflect the discontinuation of the precision equipment business.

     As a result of these decisions, and to streamline the Company’s operations and better support the commercialization of its emerging CPL semiconductor manufacturing systems and related technologies, the Company now operates in three business segments: the Research Division, the Systems Division and the Microelectronics Division.

Results of Consolidated Operations

     Total revenues for the three months ended June 30, 2003 and 2002 were $5,027,654 and $4,585,622, respectively. The net loss for the three months ended June 30, 2003 and 2002 was

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$(1,337,184) and $(1,002,165), respectively. The loss from continuing operations for those same periods was $(650,354) and $(637,039), respectively, while the loss from operations for those same periods was $(567,520) and $(112,847), respectively.

     Total revenues for the six months ended June 30, 2003 and 2002 were $9,761,368 and $8,194,277, respectively. The net loss for the six months ended June 30, 2003 and 2002 was $(2,243,841) and $(1,749,786), respectively. The income (loss) from continuing operations for those same periods was $(1,097,024) and $425,557, respectively, while the loss from operations for those same periods was $(932,655) and $(360,409), respectively.

     Included in the net loss for the three and six months ended June 30, 2003 is a loss from operations of discontinued operations of $(686,830) and $(1,146,817), respectively. Included in the net loss and loss from operations for the three and six months ended June 30, 2003 is an asset writedown of $200,056. Included in the net loss and income from continuing operations for the six months ended June 30, 2002 is a gain on the sale of marketable securities of $1,349,721. Also, included in the net loss for the three and six months ended June 30, 2002 is a loss from operations of discontinued operations of $(365,126) and $(2,175,343), respectively, and a deferred income tax expense of $484,423 resulting from an increase in the valuation allowance against the Company’s deferred tax assets.

     The increase in revenues for the three and six months ended June 30, 2003 compared to the three and six months ended June 30, 2002 was primarily attributable to an increase in contract revenues at the Microelectronics Division of $470,268 and $1,555,411, respectively, related to the receipt of approximately $5 million in contracts from General Dynamics Advanced Information Systems (“GDAIS”) in February 2003. In May, 2002, the Systems Division received an approximately $10 million contract from Naval Air Warfare Center AD for sub-100nm x-ray masks for Next Generation Lithography Systems (the “Navair Contract”). In addition, for the six months ended June 30, 2003 compared to the six months ended June 30, 2002, there was an increase in the Navair Contract revenues of $876,439 offset by a decrease in revenues related to the DARPA contract of $890,653.

     Gross margins for the six months ended June 30, 2003 and 2002 were 19.3% and 30.7%, respectively. Gross margins for the three months ended June 30, 2003 and 2002 were 19.3% and 32.0%, 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 further decrease in the gross margin in 2003 was due to lower margins at the Systems Division related to non-DARPA contracts for the six months ended June 30, 2003 (11.4%) compared to 2002 (17.1%). This reduction is related to the Navair Contract having lower margins due to its high subcontract component, and the Company’s absorption of some of the costs incurred due to limited funding on that contract. In addition, the Company started another contract later in 2002, which has low margins due to estimated costs overruns on that contract. In addition, gross margins on the DARPA contract were lower for the six months ended June 30, 2003 (30.6%) compared to 2002 (37.6%) due to higher overhead costs in 2003 at the Systems Division. Also, gross margins on the Microelectronics Division contract with GDAIS were lower for the six months ended June 30, 2003 (15.1%) compared to 2002 (34.2%) due to a contract cost overrun of $70,000 recorded in 2003 and a higher amount of material costs in 2003. The majority of the Company’s revenues in 2003 will be derived from government contracts or subcontracts, so gross margins will continue at similar levels as they have been for the first six months of 2003.

     Selling, general and administrative (“SG&A”) expenses for the six months ended June 30, 2003 and 2002 were $2,393,570 and $2,492,176, respectively. SG&A expenses for the three months ended June 30, 2003 and 2002 were $1,219,960 and $1,390,313, respectively. The decrease in SG&A expenses for 2003 was primarily attributable to lower legal costs in 2003 and a reduction in SG&A costs of the Systems Division.

     The asset writedown of $200,056 relates to an asset held by the Research Division that will not be used by the Company in the future.

     The Company’s research, development and engineering program (RD&E) consists of two types: Customer-Funded RD&E (U.S. government and other companies) and Company-Funded RD&E. Both types of RD&E costs are expensed when incurred. Customer-Funded RD&E costs incurred, included in “Costs of Sales”, totaled $3,134,489 and $2,814,968 for the three months ended June 30, 2003 and 2002, respectively, and $5,541,764 and $4,805,326 for the six month periods ended June 30, 2003 and 2002,

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respectively. The increase in Customer-Funded RD&E expenditures for the six months ended June 30, 2003 is related to an increase in other contract costs of $1,048,676 incurred by the Systems Division (approximately $797,845 of which is related to the Navair Contract) offset by a decrease in contract costs of $312,238 related to the DARPA contract. Company-Funded RD&E costs are shown in “Operating Expenses” and totaled $119,323 and $190,341 for the three months ended June 30, 2003 and 2002, respectively, and $221,832 and $383,132 for the six months ended June 30, 2003 and 2002, respectively. Hence, total RD&E expenditures for the three month periods were $3,253,812 and $3,005,309 for 2003 and 2002, respectively, and $5,763,596 and $5,188,458 for the six month periods in 2003 and 2002, respectively. Total RD&E expenditures as a percentage of sales were 64.7% and 65.5% for the three months ended June 30, 2003 and 2002, respectively, and 59.0% and 63.3% for the six months ended June 30, 2003 and 2002, respectively. These expenditures are primarily related to the continued development of collimated plasma lithography systems for the semiconductor industry.

     The loss from operations of discontinued operations of $686,830 and $1,146,817, respectively, for the three and six months ended June 30, 2003 includes $270,761 and $311,977, respectively, related to the standard semiconductor products business and $416,069 and $834,840, respectively, related to the precision equipment business. The loss from operations of discontinued operations of $365,126 and $2,175,343, respectively, for the three and six months ended June 30, 2002 includes none and $1,185,861, respectively, related to the standard semiconductor products business and $365,126 and $989,482, respectively, related to the precision equipment business. In July 2003, the Company sold JPSI to several private investors. Under the terms of the sale, JMAR received $500,000 in a combination of cash and promissory notes, and the buyer assumed 14 of the remaining 25 months of JPSI’s facility lease. The notes are secured by the assets of JPSI and the lease obligation is secured by personal property of the buyers. In addition, all JPSI receivables as of the closing were assigned to JMAR and JMAR agreed to pay all trade and employee related liabilities existing as of the closing and unknown liabilities, if any. The buyers have assumed all other ongoing commitments of JPSI. The results of operations of the precision equipment business for 2003 through the sale date are reported in discontinued operations in 2003. The decrease in the loss of discontinued operations is primarily due to the shutdown of the operations of JSI in 2002.

     In September 2000, JMAR Semiconductor, Inc. (“JSI”) moved into a significantly larger facility in anticipation of realizing its growth plans. Prior to December 31, 2001, the Company decided to take action to sublease the facility and move JSI into a smaller facility. The Company does not yet have a subtenant for this facility and, as of June 30, 2003, the Company has approximately $433,000 accrued for estimated future losses under this lease, including $150,000 accrued in the quarter ended June 30, 2003. The lease provides for rent and related expenses of approximately $36,000 per month through August 2005. If the Company is unsuccessful in obtaining a subtenant on acceptable terms, there could be further losses related to that lease.

     The gain on sale of marketable securities of $1,349,721 for 2002 is related to the sale of the Company’s remaining 545,500 shares of its investment in Bede plc (“Bede”) in January 2002.

     Interest and other expense for the three months ended June 30, 2003 and 2002 was $125,700 and $60,054, respectively, and for the six months ended June 30, 2003 and 2002 was $230,826 and $117,846, respectively. Interest and other expense are higher for 2003 versus 2002 due to the financing transactions the Company entered into in 2003 (see “Consolidated Liquidity and Financial Condition” below). Included in interest expense for the three and six months ended June 30, 2003 is $7,109 related to the beneficial conversion feature.

     Included in the loss applicable to common stock in the Statement of Operations for the three and six months ended June 30, 2003 is preferred stock dividends of $224,030 and $229,453, respectively.

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     The amount for the six months ended June 30, 2003 represents $27,604 dividends paid in cash and $201,849 related to the beneficial conversion feature.

Results of Segment Operations

     The results of segment operations (excluding corporate costs allocable to discontinued operations) for the three and six months ending June 30, 2003 and 2002 are as follows: