Overview

JMAR Technologies, Inc. is a leading innovator in the development and commercialization of sensing systems for the detection of chemical, biological, radiological, nuclear and explosive (CBRNE) materials. Coupled with its established expertise in building advanced laser systems, JMAR provides solutions for a broad range of military, industrial and commercial applications.

The Company draws on more than twenty years of experience and thirty patents in photonics, laser and detection technologies to develop products and solutions that address some of the world's most pressing issues such as water quality, hazard detection and homeland security. JMAR's vision is to continue to develop innovative technologies and products that support the advancement of global health, safety, and security initiatives. Currently, JMAR has two commercial product lines: the BioSentry® system, an on-line real-time monitoring system for detecting and classifying harmful microorganisms in water, also available in 1) a transportable version called BioSentryLab, and 2) BioAlert, an online monitoring service; and the BriteLight™ laser, a stand-alone laser product for several high power, high brightness applications, as well as the light source for x-ray microscopy.

JMAR's pursuit of cutting-edge products includes our ongoing program, the double pulse (DP) plasma laser, funded by the Army Research Laboratory (ARL) for development and demonstration of the technology. The exceptional beam quality already demonstrated will enable stand-off laser-induced breakdown spectroscopy (LIBS) applications. Light emissions from the plasma generated on targeted substances such as explosives and drugs are detected and analyzed by an optical spectrometer to provide identification of the target material. The DP laser is based on a redesign of JMAR's patented BriteLight™ laser.

Over the past 15 years, our research and development programs received in excess of $100 million in funding under DARPA and ARL contracts, which for DARPA ended in 2006, and which for ARL the funding support continues today for very different and unique technology development projects. In the nine months ended September 30, 2008 and 2007, approximately 48.1% and 55.8%, respectively, of our revenue was derived as the prime contractor or subcontractor for a government contract.

The Department of Defense's (DOD) overall budget, and our participation therein, is subject to increases and decreases based upon a number of factors, including general budgetary constraints, shifting priorities of the specific governmental agency which sponsors the funding and our own performance under our contracts with the Government. We do not expect to receive funding from government sources in the future in excess of $2-3 million per year. The Company is relying on the sale of its new products in 2008 and beyond, together with strategic alliances, to support continued product development and successful business operations.

JMAR conducts its operations in three business segments; Laser Products, Sensor Products, and Spectral Systems

The Laser Products Group, formerly named the Research Division, carries out research and development involving JMAR's patented high brightness, short pulse, diode pumped solid state lasers and laser-produced plasma (LPP) technology. A major portion of the Research Division's R&D funding has been obtained through contracts from the DARPA and more recently by the U.S. Army Research Laboratories (ARL). JMAR is continuing to enhance its product offering by extending its core technologies to include spectroscopy engineering and Raman sensing as key elements of a robust solution for substance detection and identification. In addition, the design and development of several custom lasers has been proposed for unique commercial and defense applications. As prototype products are developed, and if the projected number of sales warrant, they will be considered for transfer to a third party contract engineering firm for product manufacturing.

JMAR's diode pumped modular solid state (DPSS) BriteLight laser, developed specifically to enable the efficient production of soft x-rays through laser produced plasma, is marketed by JMAR as a standard product for advanced laser applications.

The patented DPSS BriteLight Laser system provides a high-performance laser source for researchers and engineers in academic, military and manufacturing settings requiring either a single specialized laser or a versatile laser source that can be used for a multitude of applications, including spectrochemical analysis, nano-scale fabrication, microscopy and soft x-ray source generation. This system was developed as the foundation for JMAR's collimated plasma lithography (CPL) x-ray source.

Redesigned BriteLight technology is the basis for JMAR's entry into laser-induced breakdown spectroscopy (LIBS) for remote detection of CBRNE (chemical, biological, radiological, nuclear, explosive) substances in military settings, on roadways and at checkpoints, against suspects in the field, for site exploitation, crime scenes, and for detecting the smallest possible traces of CBRNE elements. This line of business is presently supported by the U.S. Army and by internal research and development (IR&D) funds and is being expanded to examine the combination of fluorescence and Raman capabilities with DP-LIBS to provide verification of detected elements.

During the three and nine months ended September 30, 2008, and 2007, Laser Products accounted for approximately 83.3%, 69.6%, 57.0% and 60.0%, respectively of the Company's revenues.

Sensor Products Group

This segment's first product is the BioSentry sensor, a continuous, on-line, real-time monitoring system for detecting and classifying harmful microorganisms in water. The Company has recently built a portable version designed to accept and assess water samples. BioSentry is targeted toward a number of applications across multiple markets, including homeland security, beverage industries, highly visible buildings such as government embassies, pharmaceutical companies, municipal and private water utilities and the rapidly growing number of water amusement parks.

The U.S. Environmental Protection Agency (EPA) purchased a unit for evaluation of BioSentry in homeland security applications at the National Homeland Security Research Center in Cincinnati, Ohio. The program was carried out in 2007, using a pilot-scale water distribution system at the test and evaluation facility. Tests were performed to determine the detection capabilities of BioSentry and other similar products against intentional introduction of pathogens into a water distribution system. Several pathogen surrogates were used simulating lethal microbes. The EPA presented these results at the April AWWA Water Security Congress 2008 which indicated that the tests showed BioSentry able to detect bacterial pathogens up to 25 times better than any other product tested.

In January 2008, a trial BioSentry system was delivered to a major international pharmaceutical company to determine its efficacy for real-time detection and classification of waterborne microorganisms in the production of high purity water used in the pharmaceutical manufacturing process. The objective is to augment traditional "grab sample"/laboratory analysis that can take up to five days before results are obtained. Their suitability assessment should be completed in the near term.

In February 2008 JMAR delivered two BioSentry systems under a purchase order from Aquatec, a Swiss distributor of water control systems, which potentially could lead to several larger purchases because municipal water districts can be liable to their users for contamination problems. In addition, the Company is engaged in discussion with a large international water products and management company regarding their potential as a consumer and distributor of BioSentry products. Recent orders for BioSentry systems have been received for health & beauty aids and wastewater management applications.

During the three and nine months ended September 30, 2008, and 2007, the Sensor Products segment accounted for approximately 0%, 26.2%, 43.0 % and 40.0%, respectively, of the Company's revenues.

Spectral Systems Group

The Spectral Systems Group designs and develops products to detect, locate and identify radiological/nuclear threats with minimum intrusion, and was recently awarded a subcontract by Creative Electron Inc. to support efforts under a Department of Homeland Security (DHS) contract for development of a new non-intrusive inspection (NII) image processing tool. Spectral Systems has also been assigned systems integration responsibilities and in this regard is building JMAR's first DP - LIBS system for demonstration in the spring of 2009, using government and Company funding to accelerate product development for security applications.

During the three and nine months ended September 30, 2008, and 2007, Spectral Systems accounted for approximately 16.7%, 4.2%, 0 % and 0%, respectively, of the Company's revenues.

In September 2007, the Company negotiated a $7,500,000 Term Note with Laurus (the "$7.5 million Term Note"). The draw-downs under the Laurus $7.5 million Term Note have enabled the Company to continue the development of its emerging new products and for working capital requirements in 2007 and through late September 2008.

Pursuant to the $7.5 million Term Note Securities Purchase Agreement, the Company agreed that by mid-October 2007 it would discontinue all business operations and sell the assets associated with the Vermont Operations to one or more third parties and transfer any remaining assets to the Company's San Diego location. As a result, the Vermont Operations were discontinued as of September 30, 2007.

On November 7, 2007, the Company executed an Asset Purchase Agreement (the "Agreement") with Applied Research Associates, Inc. (ARA) of Randolph, Vermont to purchase certain assets of the Vermont Operations including; rights to the Vermont Operations' proposal to NAVAIR; the x-ray stepper and optical microscope hardware; and the intellectual property, including four patents, related to x-ray lithography. Under the Agreement, ARA was responsible for all lease payments of the Vermont Operations' building under a sublease from the Company for the remainder of the lease term from October 16, 2007 through its termination on March 30, 2008 and for certain costs of the building and office operation until closing of the transaction. In January 2008, JMAR received payment for the sale of the Vermont Operations, including reimbursement of certain building lease payments and operating costs for total proceeds of $218,607.

Accordingly, the Company has reflected the Vermont Operations as discontinued operations for all periods included in this Form 10-Q.

The financing provided by the $7.5 million Term Note has funded the Company's operations through late September, 2008.

In September 2008, the Company accepted interim financing of $1,750,000 from Laurus (the "$1.75 million Term Note"). Based on operating budget projections and discussions with Laurus, the Company anticipates receiving additional financing that will cover continuing operations through year-end and beyond.

The Company will require drawdowns through the near term under the $1.75 million Term Note to continue the marketing and development of emerging new products and for working capital requirements. There are no assurances that funds will be available under the $1.75 million Term Note, due to Laurus' requirement to approve every drawdown. The Company is continuing to pursue other opportunities to raise additional funds in the future. Management believes, but cannot assure, that the Company will be able to raise additional funds through equity or other financings to fund future operations. This belief is derived from the Company's historical access to equity and debt markets. See further discussion in Note 1 in the accompanying Notes to Consolidated Financial Statements and "Risk Factors" in Part II - Item 1A below.

Sources of Revenue

Contract Research and Development, Technical Support, and Production Programs

The majority of JMAR's revenues has been derived as the prime contractor or subcontractor for government contracts. These contracts have generated intellectual property owned by the Company in areas in which JMAR believes there are significant commercial applications.

Standard Products

The Company is engaged in discussion with a large international water products and management company regarding their potential as a consumer and distributor of BioSentry products. JMAR has placed a small number of units with commercial and government customers, including a beverage company, several water utilities and federal agencies. Additional product development was recently completed to take full advantage of the potential markets for the BioSentry system. Because of the interest received at recent trade shows and the mounting number of inquiries on the product price and availability, JMAR is promoting a greater awareness of the product and augmenting its marketing and sales staff.

JMAR's diode pumped solid state BriteLight Laser, developed specifically to enable the efficient production of soft x-rays using laser produced plasma, is now marketed by JMAR as a standard product for advanced laser applications. Commercial BriteLight units are presently operating in Japan, Korea and at the Lawrence Livermore National Laboratory. In addition, we anticipate the adoption of BriteLight as the x-ray source for compact microscopy applications. JMAR is conducting manufacturing engineering analysis to reduce production costs and to expand the addressable market for this high performance laser.

New Products Under Development

JMAR's pursuit of cutting-edge products includes our ongoing development of the double pulse (DP) plasma laser, funded by the Army Research Laboratory (ARL) for development and demonstration. The exceptional beam quality already demonstrated will enable stand-off laser-induced breakdown spectroscopy (LIBS) applications. Light emissions from the plasma generated on targeted substances such as explosives and drugs are detected and analyzed by an optical spectrometer to provide identification of the target material. The DP laser is based on a redesign of JMAR's patented BriteLight™ laser.

Due to the support of our financing source, Laurus Funds, JMAR contracted with D&K Engineering to accelerate the transition from laboratory prototype to a portable double pulse laser product. This project has been further expanded to include the integration of analytic components for system-level LIBS with laser-induced fluorescence (LIF) and Raman applications designed to detect and identify biological contaminants and chemicals used in explosives, metals, drugs, and other substances of critical national security interest. To maximize its resources for this critically important product development, JMAR has submitted a phase III proposal for continued government funding.

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 to commercial introduction and market acceptance. See "Risk Factors" in Part I, Item 1A of our Form 10-K for the year ended December 31, 2007 for more information on the risks and uncertainties faced by JMAR.

Results of Operations

Revenues. Total revenues from continuing operations for the three months ended September 30, 2008 and 2007 were $71,145, and $93,306, respectively. Revenues for the nine months ended September 30, 2008 and 2007 were $284,106 and $433,102, respectively. The majority of the Company's revenues for all of these periods were contract revenues. Revenues for the three and nine months ended September 30, 2008 and 2007 were as follows (unaudited):

                                                   Three Months Ended                       Nine Months Ended
                                            September 30,       September 30,       September 30,       September 30,
                                                2008                2007                2008                2007
Sensor Products Group                      $            -      $       40,122      $        74,527     $       172,069
Laser Products Group                                59,245              53,184             197,679             261,033
Spectral Systems Group                              11,900                   -              11,900                   -
                                           $        71,145     $        93,306     $       284,106     $       433,102

The decrease in revenues for the three months ended September 30, 2008 compared to the three months ended September 30, 2007, was due primarily to a reduction in revenue from sales of BioSentry. The decrease in revenues for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007, was due to a $116,754 reduction in revenues from our SBIR contract and a $97,542 reduction in revenues in the Sensor Products Group. Partially offsetting these decreases was an increase of $53,400 of BriteLight and $11,900 of Spectral Systems sales from the nine month period ended September 30, 2008 compared to the nine month period ended September 30, 2007. As discussed above in "Sources of Revenue", the Company reflects the Vermont Operations as a discontinued operation.

Income/ (Losses). The net income/ (loss) for the three months ended September 30, 2008 and 2007 was $8,988,808 and $(893,099), respectively and for the nine months ended September 30, 2008 and 2007, the net income/ (loss) was $(19,406,534) and $(2,627,359), respectively. The income/ (loss) from continuing operations for the three months ended September 30, 2008 and 2007 was $ 8,864,122 and $(784,333), respectively, and for the nine months ended September 30, 2008 and 2007 the income/ (loss) from continuing operations was $(19,406,534) and $(3,203,975), respectively. The $9,757,221 increase in net income for the three months ended September 30, 2008 as compared to the loss for September 30, 2007 is principally due to a reduction in the fair value of derivative liability of $6,610,010, a reduction in interest and other expense of $4,616,455 and a reduction in the loss from discontinued operations of $108,766, principally offset by an increase in selling, general and administrative expenses of $1,233,473 and an increase in the costs invested in product development (see further discussion below) of $285,977. The $16,779,175 increase in the net loss for the nine months ended September 30, 2008 as compared to September 30, 2007 is principally due to relatively greater increased change in the fair value of derivative liability of $16,806,192, plus an increase in selling, general and administrative expenses of $1,555,452 , an increase in product development (see further discussion below) of $814,389, a reduction in the income from discontinued operations of $576,616, a reduction of other income from sales of assets of $520,167 and a reduction of gross profit of $115,929, offset by a reduction in interest and other expense of $3,545,642 and by a reduction in asset write-downs of $125,117.

Gross Margins. Gross margins for the three months ended September 30, 2008 and 2007 were 17.2 % and 7.6 %, respectively. Gross margins for the nine months ended September 30, 2008 and 2007 were 1.6 % and 27.8%, respectively. The Company's margins were higher in the three months ended September 30, 2008 compared to the three months ended September 30, 2007 due to higher gross margin earned on the SBIR Contract in 2008 than on SBIR and BioSentry revenue in 2007. The Company's margins were lower in the first nine months of 2008 as compared to the first nine months of 2007 principally due to a loss on the sale of a laser product in the first quarter of 2008. The Company is investing in new product development activities that it believes will lead to increased sales and higher margin products in the future.

Selling, General and Administrative (SG&A). SG&A expenses were $1,901,147 and $667,674 for the three months ended September 30, 2008 and 2007, respectively, and $4,029,991 and $2,474,539 for the nine months ended September 30, 2008 and 2007, respectively. The increase in SG&A expenses for the three months ended September 30, 2008 compared to 2007 was primarily attributable to an increase in professional fees -including legal, accounting and proxy services - of $739,815, stock-based compensation of $154,843, salaries and benefits of $153,678, marketing support, advertising and industry show expenses of $107,086 and recruitment and relocation costs of $13,719 for new employees. The increase in SG&A expenses for the nine months ended September 30, 2008 compared to 2007 was principally due to increases in professional fees - including legal, accounting and proxy services - of $982,989, stock-based compensation of $239,885, recruitment and relocation costs of $141,655 for new employees, marketing support, advertising and industry show expenses of $124,824 and salaries and benefits of $64,710.

Research, Development and Engineering Program (RD&E). The Company's RD&E consists of two types: customer-funded RD&E (U.S. government) 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 SBIR Contract, are included in "Costs of Revenues", and totaled $58,912 and $61,141 for the three months ended September 30, 2008 and 2007, respectively, and $98,082 and $230,790 for the nine month periods ended September 30, 2008 and 2007, respectively. The decrease in customer-funded RD&E expenditures for the three months ended September 30, 2008 relative to 2007 primarily consists of a decrease of $20,087 related to the SBIR Contract, offset by an increase of $11,900 from Spectral Systems. The decrease in customer-funded RD&E expenditures for the nine months ended September 30, 2008 relative to 2007 primarily consists of a decrease of $132,707 related to the SBIR Contract.

? Company-funded RD&E costs associated with product development are shown in "Operating Expenses" and totaled $349,408 and $63,431 for the three months ended September 30, 2008 and 2007, respectively, and $1,293,998 and $479,609 for the nine months ended September 30, 2008 and 2007, respectively. The increase in 2008 is primarily due to increased product development expenditures related to the DP-LIBS and UV laser.

Total RD&E expenditures for the three month periods were $408,320 and $124,572 for 2008 and 2007, respectively, and $1,392,080 and $710,399 for the nine month periods in 2008 and 2007, respectively. Total RD&E expenditures as a percentage of revenues were 574% and 134% for the three months ended September 30, 2008 and 2007, respectively, and 490% and 164% for the nine months ended September 30, 2008 and 2007, 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 have been R&D contract revenues. In addition, the Company's revenues have been declining.

Discontinued Operations. The income/ (loss) from operations of discontinued operations was $0 and $(108,766) for the three months ended September 30, 2008 and 2007, respectively and $0 and $576,616 for the nine months ended September 30, 2008 and 2007, respectively. The income from operations of discontinued operations is related to the Vermont Operations, which was discontinued as of September 30, 2007.

On November 7, 2007, the Company executed an Asset Purchase Agreement (the "Agreement") with Applied Research Associates, Inc. (ARA) of Randolph, Vermont to sell to ARA certain assets of the Vermont Operations including; rights to the Vermont Operations' current proposal to NAVAIR; the x-ray stepper and optical microscope hardware; and the intellectual property, including four patents, related to x-ray lithography. Under the Agreement, ARA was responsible for all lease payments and certain other facility operating costs of the Vermont Operations' building under a sublease from the Company for the remainder of the lease term from October 16, 2007 through its termination on March 30, 2008. In January 2008, JMAR received payment for the sale of the Vermont Operations, including reimbursement of certain building lease payments and operating costs for total proceeds of $218,607.

The Company has reflected the Vermont Operations as discontinued operations for all periods included in this Form 10-Q.

Interest and Other Expense. Interest and other expense for the three months ended September 30, 2008 and 2007 was $1,266,806 and $5,883,261, respectively, and for the nine months ended September 30, 2008 and 2007 was $3,785,359 and $7,331,001, respectively. Interest and other expense was $4,616,455 lower for the three months ended September 30, 2008 compared to 2007 principally due to the $5,590,000 derivative liability recorded in 2007 related to warrants attached to the $750,000 and $7.5 million Term Notes from Laurus and higher cash interest of $73,238, principally due to greater borrowings under the term notes, offset largely by amortization of debt discount of $1,011,720 in 2008 as compared to $93,750 in 2007. Interest expense was $3,545,642 lower for the nine months ended September 30, 2008 compared to 2007 principally due to the $6,587,481 derivative liability recorded in 2007 related to warrants attached to the $750,000 and $7.5 million Term Notes from Laurus, offset largely by amortization of debt discount of $3,034,890 in 2008 compared to $187,500 in 2007 and an increase in cash interest expense of $199,012 largely due to the greater utilization of the Company's $7.5 million Term Note. Included in non-cash interest expense for the three months and nine months ended September 30, 2008 and 2007 is $21,180, $72,618 and $63,540, $217,854 respectively, related to the beneficial conversion feature and fair value of warrants issued in connection with the Working Capital Line, and the $750,000 and $7.5 million Term Notes 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.

Preferred Stock Dividends. Included in the loss applicable to common shareholders in the accompanying Consolidated Statements of Operations for the three months ended September 30, 2008 and 2007 are deemed preferred stock dividends of $205,678 and $578,467, respectively. The amounts for the three months ended September 30, 2008 and 2007 consist of $106,338 and $159,243 of preferred stock dividends paid or payable in cash and $99,340 and $419,224 of the discount representing the beneficial conversion feature of the redeemable convertible preferred stock, the fair value of warrants issued in connection with the preferred stock and the difference between the fair value of the preferred stock immediately prior to and after certain prior amendments to the preferred stock.

Included in the loss applicable to common shareholders in the accompanying . . .