Item 1. BUSINESS
General
JMAR Technologies, Inc. (JMAR or Company) is an innovator in the development of laser-based technology and x-ray processes for nano-scale imaging, analysis and fabrication. The Company is leveraging more than a decade of laser and photonics research to develop a portfolio of nanotechnology products with commercial applications in rapidly growing industries, while continuing to carry out research and development for the U.S. Government.
JMAR’s BioSentry product is a contamination warning system for waterborne microorganisms using laser-based, multi-angle light scattering technology to provide continuous, on-line, real-time monitoring for harmful microorganisms. BioSentry is targeted toward a number of applications across multiple markets, including homeland security, the cruise ship and beverage industries, pharmaceutical companies, and municipal water utilities. To date, JMAR has received a limited number of orders of its BioSentry product from several local domestic and foreign government agencies, a beverage manufacturer, a water municipality and a cruise ship operator. In early 2007 the Company received a purchase order from a leading U.S. government agency to install a BioSentry system at a key overseas facility.
JMAR’s pursuit of leading edge products targets nanotechnology, bioscience and the semiconductor industries with its BriteLight laser, a stand-alone product as well as the x-ray light source in nanolithography systems; the X-ray Microscope for 3D visualization of single cells and polymers; and development of the X-ray Nano Probe for enabling nano-scale interaction, analysis and materials modification. In addition, JMAR employs a key strategic alliance for the production of a hazardous materials chemical sensor, and the prototyping and production of a nanoparticle ultra-thin coating system.
“BioSentry®” is a registered trademark and “BriteLightTM” is a trademark for which we have common law rights.
JMAR was incorporated in the state of Delaware in 1987.
Business Segments
JMAR conducts its operations in the following two business segments:
Research Division/Vermont Operations
Research Division - Located in San Diego, California, the Research Division 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 the U.S. Defense Advanced Research Projects Agency (DARPA) of the U.S. Department of Defense. The Research Division’s historic focus on X-ray lithography light source R&D and equipment development was broadened in 2004 when it embarked on an effort to identify additional uses for its laser and LPP technologies. As a result of this effort, the Research Division is developing several soft X-ray enabled products including a family of instruments for nanotechnology applications. JMAR believes that this instrument family will provide the ability to carry out imaging and chemical analysis at resolutions down to 20 nanometers.
New products that are developed at the Research Division based on contract and internally funded R&D are then transitioned to JMAR’s Vermont Operations for product engineering and production.
Vermont Operations - Located in South Burlington, Vermont, the Vermont Operations carries out contract research and development involving nanolithography and serves as JMAR’s manufacturing arm, carrying out the 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. In addition the Vermont Operations performs funded contract research and development for DARPA and the Naval Air Warfare Center (Navair). During 2006, the Research Division/Vermont Operations segment accounted for approximately 98% 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. BioSentry is targeted toward a number of applications across multiple markets, including homeland security, the cruise ship and beverage industries, pharmaceutical companies, and municipal water utilities. During 2006, this segment accounted for 2% of the Company’s revenues.
Products and Services
JMAR’s products and services evolve from one or more of its four core competencies: high brightness solid state lasers, laser produced plasma generators for soft X-ray light, automated precision positioning and alignment systems, and multi-angle light scattering for particle classification. These competencies form the basis for JMAR’s contract research and development and standard and custom products.
BriteLight Lasers
JMAR’s diode pumped modular solid state (DPSS) BriteLight laser, developed specifically to enable the efficient production of soft X-rays, using laser produced plasma, is marketed by JMAR as a standard product for advanced laser applications. Commercial BriteLight units are presently operating in Korea and at the Lawrence Livermore National Laboratory.
The patented DPSS BriteLight Laser System offers a unique combination of high brightness, short pulse duration, and exceptional beam quality in a modular, compact design. This product offers research scientists and manufacturing engineers 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.
The BriteLight System is 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 system capable of future augmentation. This system, developed as the foundation for JMAR’s Collimated Plasma Lithography (CPL) X-ray source, also drives the X-ray light source for JMAR’s Compact X-ray Microscope. BriteLight technology is also the basis for JMAR’s research into laser-induced breakdown spectroscopy (LIBS) for remote detection of hazardous materials (Improvised Explosive Devices, or IEDs) in the field, supported by a SBIR Phase II contract from the U.S. Army.
We have representation and sales agreements for BriteLight with LOT-Oriel, covering Europe, with Lastek, covering Australia and with SP Systec, covering South Korea.
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 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 to ≤10 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
JMAR’s compact soft X-ray Microscope (XRM) is intended to bridge the sizeable gap between optical microscopes, which are typically greater than 200 nm resolution, and transmission electron microscopes that resolve feature sizes as small as 0.1 nm. Proposed key advantages of the XRM include the ability to provide not only 2D images, but full 3D topographic reconstructions of whole cells, without altering the cell structure by slicing. Additionally, soft x-rays provide natural contrast for cell imaging, eliminating the need for staining. This greatly reduces sample preparation time and complexity, as compared to transmission electron microscopy, while still providing high resolution imaging to the 50 nm level.
Several XRM systems are attached to synchrotron beam lines around the world and are used for imaging biological and other specimens. JMAR’s innovation is to replace the synchrotron as an x-ray source with a commercially-oriented compact X-ray source, enabling researchers in the biological and life sciences arenas to do in their own research laboratories, enabling an acceleration of research. Currently this is only possible at a few larger scale facilities worldwide.
In March 2007, the Company entered into an agreement with a leading microscopy company under which JMAR sold the assets of its XRM product line, including the intellectual property related to that specific application and its prototype XRM system. The consideration for this sale consists of an initial payment of $100,000 and the reimbursement of $50,000 in associated costs, a payment of $500,000 once the XRM is operational at the acquirer’s facility, expected to be in April 2007, an additional $100,000 payment following achievement of certain performance criteria and the payment of a royalty on the future sale of XRM units by the other party. The other party also agreed to appoint JMAR as exclusive laser supplier during the four-year royalty period.
Compact X-ray Nano Probe
In February 2006, we entered into a licensing agreement with Colorado State University Research Foundation (CSURF) as agent for Colorado State University (CSU) for the use of its discharge pumped soft X-ray laser for a specific application, developed under the auspices of the National Science Foundation’s (NSF) Engineering Research Center for Extreme Ultraviolet Science and Technology (EUV ERC). This laser produces high-intensity soft X-ray radiation at a wavelength shorter than any other laser on the market today and complements our LPP X-ray source that produces even shorter wavelengths.
The CSU soft X-ray laser enhances JMAR’s ability to create in the future an entirely new class of analytical instruments and nanostructure characterization tools. Characterized by a combination of high-spatial resolution (50nm) and ultra-high detection-sensitivity, we believe instruments and tools using CSU soft X-ray laser technology will enhance nanotechnology, life science and materials research.
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 Gallium Arsenide-based materials (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. Since 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 product discussed above, as well as our x-ray Nano Probe products (XNP). For example, certain components used in nanotechnology applications require focusing elements called zone plates which can be manufactured using x-ray lithography. The Company is applying its lithography expertise to develop a zone plate manufacturing capability for its XRM and XNP products. The Company believes that if GaAs chip producers dramatically increase IC production in the future, X-ray lithography may present a significant business opportunity for JMAR.
BioSentry
In 2005, JMAR acquired new technology and established a Sensor Products Group to develop and field an innovative sensor for continuous, on-line, real-time monitoring of drinking water for the presence of harmful microorganisms. The BioSentry successfully passed proof of concept testing and we assembled fifteen Beta units and seven gamma units for internal testing and installation at test and evaluation sites for different applications in the first and second quarters of 2005.
The following is a summary of the orders received to date for BioSentry systems:
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In April 2005, we entered into a contract with Kimpen S.A. de C.V. (Kimpen), Mexico’s largest bottler and a subsidiary of one of Mexico’s leading beverage development and manufacturing companies (Bepensa) to install a Beta model of the BioSentry at Kimpen’s laboratory. After successful completion of Beta testing, Kimpen purchased two BioSentry production systems for installation in beverage production facilities. Kimpen had originally indicated that after successful testing of these two units they would purchase 15 more units, however, they suspended this 15
unit order due to financial constraints at Bepensa. Kimpen and JMAR have formally agreed to cooperate to reinstate the 15 unit order by joint selling efforts to each of 15 Bepensa beverage plants. The two purchased units were shipped in 2006 and were undergoing installation and start-up testing at the end of March, 2007.
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In May 2005, a leading North American cruise ship operator requested installation of the BioSentry on a cruise ship. During the quarter ended June 30, 2006, we received an order for a BioSentry for this cruise line.
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In November 2005, we entered into an agreement with the City of Anaheim to install in a central public facility and test the BioSentry for homeland security application for deliberate, harmful biological contamination of drinking water. The testing was successfully completed during the quarter ended June 30, 2006.
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In December 2005, the City of Wichita purchased two BioSentry systems to help protect the city’s drinking water against the possible introduction of Cryptosporidium or other harmful microorganisms. These units were shipped in 2006 and were undergoing installation and start-up testing at the end of March 2007.
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In late December 2006, we received a purchase order from the University of Arizona Water Quality Center for a BioSentry to be used in extensive ongoing research for real-time detection, tracking and remediation of bioterror and accidental contamination events within water distribution systems. We understand that the City of Tucson is also interested in the planned research to further determine the expected value of installing BioSentry systems in their water treatment and distribution systems.
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In late December 2006, we received a purchase order from Yorkshire Water Services Ltd. to install and test the BioSentry in a major utility facility in the U.K. Yorkshire Water has agreed to lease the BioSentry for an evaluation period of six months. Upon successful completion of the test period, they will have the option to purchase the unit for permanent installation.
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In March, 2007, the Company received an order for one BioSentry from a leading government organization. The BioSentry will be used to monitor source water in a major facility to detect the presence of a variety of pathogens.
During 2006, we entered into various representation and distributor agreements covering several market verticals. Also, in January 2007, we entered into a non-exclusive Original Equipment Manufacturers (OEM) Agreement with Micro Imaging Technology (MIT). This OEM agreement enables JMAR to sell MIT’s table-top, rapid microbial identification system as a complement to the BioSentry, or as a stand-alone unit for laboratory sample evaluation.
Starting in December 2006, the U.S. Environmental Protection Agency (EPA) began an evaluation of the BioSentry for Homeland Security applications at the National Homeland Security Research Center in Cincinnati, Ohio. The evaluation is planned to be completed in April 2007. Thus far, test results obtained indicate that the BioSentry system has performed up to several orders of magnitude better than any real-time monitor tested thus far by the EPA.
Given the Company’s limited resources and current financial condition, the Company has been exploring several alternatives for funding the further commercialization and sale of its BioSentry product. In June 2006, JMAR announced that it had engaged Agile Equity to help the Company identify a strategic partner for the BioSentry water system business that would provide the necessary funding and sales and distribution network to accelerate growth of that product. In addition, in July 2006, the Company engaged Vencon Management, Inc. to, among other tasks, find a financial partner for BioSentry. Discussions with several potential partners regarding both spin-off and joint venture opportunities continue into March 2007. To ensure the commercial success of BioSentry, recognizing that JMAR does not have adequate clout in the water industry marketplace (such as in the areas of marketing, sales, and distribution), we recently briefed and demonstrated BioSentry for a large Fortune 300 company, This company is now performing due diligence, including speaking with the EPA and our BioSentry customers. The Company believes that BioSentry fits very well with their stable of water analysis products. However, there can be no assurance that that company or any other company will choose to invest in, acquire or otherwise support the BioSentry business area. In the event that JMAR is unsuccessful in the next several months in either raising additional funding for the BioSentry business area, entering into a strategic or other financial partnership to support the BioSentry product line, or in selling significant numbers of BioSentry products, JMAR will need to curtail further significant investment in the BioSentry product line until such time as such a transaction can be completed, which would have a significant adverse impact on the viability of the BioSentry business area.
Nanoparticle Coating System
Under an agreement with Nanometrix, a Canadian company, JMAR licensed a patented process that produces unique ultra-thin coatings for substrates of a wide range of materials. With government R&D funding, JMAR’s Vermont Operations is building a prototype unit to demonstrate the benefits of this immersion coating process over the traditional spin process. At a recent International Institute for Electrical and Electronics Engineers (IEEE) conference, we presented samples of coatings on 300mm wafers using this technique. Considerable interest was expressed by semiconductor and optics companies in this new technology.
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. The Company has recently shipped a beta unit of the READ system to FemtoTrace and has received an initial payment and a Note providing for installment payments of the balance owed on the purchase price for that system. Given FemtoTrace’s financial condition and disagreements from time to time with JMAR over its performance under the agreement, any continued business with FemtoTrace is uncertain and subject to further negotiation between the companies.
Markets
BriteLight Lasers
Applications for short pulse DPSS lasers include materials science, analytical instruments, research instruments, laser-induced breakdown spectroscopy (LIBS) for remote detection of hazardous materials in the field, 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.
Sources of soft X-ray light have been limited to the approximately 30 synchrotron facilities worldwide. JMAR’s LPP based soft-X-ray source for the first time offers an alternative source that is sufficiently compact for placement in research laboratories. 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 biomedical research (e.g. hydrated whole cell imaging, proteomics), polymer research, and pharmaceutical research. JMAR has targeted 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, biological material 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 $300 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. Pursuant to the agreement entered into in March 2007 with a leading microscopy company (Acquirer) which provides for the sale of the XRM technology and assets to the Acquirer, JMAR’s continued involvement in the XRM business area will be limited to the supply of laser systems to the Acquirer for incorporation into the Acquirer’s XRM products and the receipt of royalty payments for a four year period after the first sale of an XRM unit using JMAR’s technology. At this time, JMAR cannot reliably estimate the amount of revenue expected in the future from the sale of lasers to the Acquirer and from the royalties from the sale of XRM systems by the Acquirer.
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 (XNP): nanotech research, integrated circuit failure analysis and mask inspection, pharmaceutical research, and advanced materials research. JMAR is continuing to explore the prospects of these potential markets.
Collimated Plasma Lithography (CPL)
Semiconductor integrated circuits 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 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.
The BioSentry is a compact, moderately priced early warning system that is expected to be of value to the drinking water industry, water bottlers, cruise ship operators, 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 food and beverage processors, 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.
Presently, drinking water from utilities, cruise ships and beverage producers 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 72 hours, allowing potentially contaminated water to be consumed or requiring costly decontamination.
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 have sold initial BioSentry units to a varied group of commercial and governmental customers, but have not yet received any significant multi-unit orders.
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 Coherent. Although JMAR believes its BriteLight lasers have competitive performance advantages over lasers sold by its competitors, JMAR has sold only a few BriteLight lasers to date.
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. See “Products and Services, Compact X-ray Nano Probe” above regarding a License Agreement entered into between JMAR and one of these universities. Several companies manufacture micro-focus X-ray sources for the research community, but micro-focus X-rays offer very different energy levels and are of limited use for the soft X-ray instrument 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 become competitors within two years after the BioSentry is launched. Indirect competition includes the suppliers of complex water filtration systems, expensive ultraviolet disinfection systems and standard grab sample techniques.
Customers and End Users
For fiscal years 2006, 2005 and 2004, the United States Government accounted for approximately 90%, 71% and 85%, 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 similar customers needing the unique features offered by BriteLight. In October 2005, the Company was competitively selected for a Phase I SBIR grant by the U.S. Army to support research leading to the development of a compact laser system capable of real-time spectrochemical hazard analysis in the field. This new detection approach is based on JMAR’s BriteLight technology and offers an improved method of detecting hazardous materials from a safe, remote location utilizing laser-induced breakdown spectroscopy. In September 2006, we received an award for $711,000, including a $210,000 option, in Phase II SBIR funding to continue this development. Under the Phase II contract, we are designing and building two prototypes to demonstrate both man-portable and vehicle-mounted systems.
BioSentry
In 2005, Kimpen purchased two early prototype BioSentry units and a major city contracted JMAR to evaluate the system for securing a major building from possible water contamination. The city of Wichita purchased two of these units for evaluation in utility water distribution systems as an early warning system, and the City of Anaheim installed a unit for testing in a central public facility. In 2006, a leading North American cruise ship operator purchased a unit, and the University of Arizona Water Quality Center purchased a unit. Also, the City of Anaheim and Yorkshire Water placed an order to install a BioSentry for testing in a major utility facility in the U.K. We expect the Sensor Products Group to sell its BioSentry product to the utility water security, cruise ship, homeland security, pharmaceutical, and beverage processing markets in 2007, as well as to selected government sites for warning against possible contamination acts.
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 soft X-ray light source (DARPA Contract) and an additional approximately $22 million investment in DoD funds for stepper development at Semiconductor Advanced Lithography, Inc. (SAL) prior to JMAR’s acquisition of SAL. The Company expects no further funding under the DARPA Contract.
However, a contract issued to JMAR’s Vermont Operations by Naval Air Warfare Center AD now supports continued X-ray nanolithography technology and infrastructure development. Under this contract, JMAR procures sub-100 nm feature size X-ray masks used in the development and production of high-speed C-RAM with 50-35 nanometer features, enabling 16 megabyte and higher densities for high-priority military and space applications (NAVAIR Contract). A total of $15.5 million has been received under this contract, including $3.1 million funded in August 2006. The present total contract amount is $17.5 million, with incremental funding under the contract sought on an annual basis.
Manufacturing
JMAR has sufficient facilities and staff for limited production of 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 put in place the Enterprise Resource Planning and Engineering Design Control systems to manage the production process and has demonstrated core competence in small volume production of complex products, such as BioSentry. 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. To enhance its manufacturing capability, the Company implemented a new ERP system in 2005. This tool-set links 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 alternate sources of supply for the components used in our future production systems, there are no assurances that additional suppliers will materialize. In particular, XRM and XNP-like products require a specific design of 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. Expertise for in-house manufacturing of these zone plates lies within the Vermont Operations.
Sales and Marketing
During 2005 and 2006, JMAR’s sales and marketing effort has been focused on entering into representation and distribution agreements with respected sales organizations. Currently, 19 representatives and distributors have contracted to sell BioSentry systems in various market verticals including water utilities and municipalities, pharmaceutical and marine in select areas in the U.S., Europe, Mexico, Asia and Australia. In addition, JMAR has entered into representation and sales agreements with LOT-Oriel, Lastek Pty, and SP Systec, Ltd. for representation of the BriteLight. As part of its marketing activities, JMAR also showcases its products at product conferences to broaden the exposure of its products to new customers.
Research and Development
The majority of JMAR’s R&D effort has been carried out under contracts from the U.S. Department of Defense (“DoD”). 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. Starting in 2005, 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 $2,703,257, $3,049,439, $1,642,781, $529,039 and $854,306 for the years ended December 31, 2006, 2005, 2004, 2003 and 2002, respectively. Total expenditures for RD&E, including funding provided by third party contracts from the U.S. government and other companies, were $6,275,741, $5,926,451, $5,636,643, $10,135,784 and $12,383,221 for the years ended December 31, 2006, 2005, 2004, 2003 and 2002, respectively.
Since January 2004, the Company received approximately $17 million in financing from various institutional and accredited investors. JMAR has used 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 21 U.S. patents and 10 foreign patents. JMAR currently has filed 18 pending U.S. patent applications, 8 pending foreign applications and 4 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, Advanced Optical Scanning Microscope 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 2024. Some of the more recent pending and provisional applications cover aspects of the BioSentry product.
In 2004 and 2005, JMAR entered into exclusive licenses with PointSource Technologies, LLC and The LXT Group covering technology, including issued U.S. patents and pending patent applications, that are related to our BioSentry products. In addition, JMAR has six patents pending for BioSentry hardware and software and in specific applications.
The Company’s policy is to apply for a patent on each of its significant inventions not only to preserve its proprietary rights but also to protect against reverse engineering by others and to avoid being “locked out” of the use of its own technology by other patents. 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 40 full-time employees. In connection with cost-cutting measures, a number of the Company’s employees have been terminated and several others have resigned. In addition, the Company’s Chief Financial Officer recently resigned to pursue other interests. The Company recently hired a new Chief Financial Officer who is focused on efforts to bring in additional financing for the Company. 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 two segments as follows: Research Division/Vermont Operations and Sensor Products Group. Financial information relating to the Company’s segments, significant customers and export sales for the three years ended December 31, 2006 is incorporated by reference from Note 13 of Notes to Consolidated Financial Statements.
Item 1A.
Item 1A. RISK FACTORS
Our ability to achieve our operating and financial goals is subject to a number of risks, including risks relating to our business operations, our ability to finance our operations, and technical risks associated with our new products. If any of the risks actually occur, our business, operating results, prospects or financial condition could be materially and adversely affected. The risks below are not the only ones that we face. Additional risks not presently known to us or that we currently deem immaterial may also affect our business operations.
Our continuing decline in revenues and our net and operating losses are significant and could have an adverse impact on our stock price.
Our revenues, exclusive of discontinued operations, for the years ended December 31, 2006, 2005 and 2004 were $4,857,092, $5,764,252 and $6,361,562, respectively. Our net loss for 2006, 2005 and 2004 was $13,106,681, $8,032,803 and $5,632,140, respectively. If not reduced, our continuing product development efforts will lead to increased expenditures and will increase the amount of our losses. Failure to achieve significant sales of our new products in the future and continued losses will further reduce our shareholders’ equity and will have a significant adverse impact on our stock price.
Our cash requirements are significant and the failure to generate sufficient funds from operations or obtain additional financing has had and will continue to have a significant adverse effect on the Company’s financial condition and its operations.
Our cash used in operating activities for the years ended December 31, 2006, 2005 and 2004 was $6,595,411, $4,806,376 and $4,431,232, respectively. These negative cash flows are primarily related to operating losses, discontinued operations, and fluctuations in working capital items.
We will continue to use cash in 2007 for 1) product 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 redemptions and dividends; and 4) other working capital needs. Although we have been successful in raising funds in the past, there can be no assurance that we will be able to successfully raise funds in the future. The failure to raise additional capital will have a significant adverse effect on the Company’s financial condition and its operations.
You will experience additional dilution if the Company is not successful in selling its new products.
We intend to continue to invest significant funds in our new product development programs, as well as seek financial partners for further product development, and will need to raise additional funds in order to continue our sales and marketing activities and for other working capital needs in 2007. In such event, we would expect to seek to raise such capital through the sale of our equity securities, and, as a result, shareholders will experience significant further dilution. There can be no assurance, however, that we will be able to raise such additional financing or enter into such partnerships.
Our outstanding preferred stock has a liquidation preference of $7,850,000, which is in excess of our total stockholders’ equity.
Our currently outstanding Convertible Preferred Stock has a total Stated Value of $7,850,000 as of March 26, 2007. Upon the dissolution, liquidation or winding up of the Corporation, whether voluntary or involuntary, the holders of the Company’s Preferred Stock are entitled to receive, before any payment or distribution shall be made on the common stock out of the assets of the Corporation available for distribution to the stockholders, the Stated Value per share of the Company’s Preferred Stock then outstanding and all accrued and unpaid dividends. In the event of a dissolution, liquidation or winding up of the Corporation, holders of common stock may lose their entire investment.
Our working capital line of credit, as well as the obligations under our Preferred Stock, are secured by the grant of a security interest in all of our assets and upon a default the lender may foreclose on all of our assets.
Pursuant to the terms of the Preferred Stock, the Company is required to make monthly dividend payments and to make payments to redeem shares of the Preferred Stock in monthly installments, with a large balloon payment due in 2008. These obligations, as well as the Company’s obligations under its working capital line of credit with the same party (the outstanding balance of which was approximately $975,000 as of March 26, 2007), are secured by the grant of a security interest in all of the Company’s assets. In the event of the Company’s failure to make such payments or to comply with the terms of the working capital line of credit, the other party can declare a default and seek to foreclose on the Company’s assets. If the Company is unable to repay or refinance such indebtedness, the holders of the Company’s common stock may lose their entire investment.
“Weaknesses in our internal control over financial reporting could result in material misstatements in our financial statements.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal controls are processes designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles. A material weakness is a control deficiency, or combination of control deficiencies, that results in a more than remote likelihood that a material misstatement of annual or interim financial statements will not be prevented or detected.
Management determined that material weaknesses in our internal control over financial reporting existed as of December 31, 2006 with regard to 1) lack of segregation of duties; 2) lack of timely completion of financial control and reporting and 3) lack of formal internal control environment. Management of the Company believes that these material weaknesses are due to the small size of the Company’s accounting staff, exacerbated by the resignation of the Company’s Chief Financial Officer and Corporate Controller prior to the completion of the audit. Management has taken recent actions to replace these positions, however, the small size of the Company’s accounting staff may prevent adequate controls in the future such as segregation of duties due to the cost/benefit of such remediation. See “Item 9A - Controls and Procedures” for a more complete description of this material weakness.
We cannot assure you that additional control deficiencies or material weaknesses will not be identified by our management or independent registered public accounting firm in the future. In addition, even after having taken steps to remediate these weaknesses, our internal controls may not prevent all potential errors or fraud. Any control system, no matter how well designed and implemented, can only provide reasonable and not absolute assurance that the objectives of the control system will be achieved. Failure to achieve adequate internal control over financial reporting could adversely affect our business operations and financial position.”
If our product development programs are not successful, it will harm our business.
The development of sophisticated laser-based systems and sensors, such as our BioSentry and our X-ray Nano Probe products, is a lengthy and capital intensive process and is subject to unforeseen risks, delays, problems and costs. We have had limited success in past product development efforts, including the failure to achieve market acceptance of our Collimated Plasma Lithography (CPL) products and in our efforts to establish a standard semiconductor products business. We cannot assure you that we will be able to successfully develop our new products, or that unanticipated technical or other problems will not occur which would result in delays in our development programs.
Achieving market acceptance for our new products requires a significant effort to convince customers to adopt our products and technologies over other alternative products and technologies. In the case of each of our new product development efforts, this requires demonstrating that our products have superior performance to the alternative products and technologies and are more cost-effective. In addition to the expenditures required to complete and commercialize these products, this will require substantial technical, marketing and sales efforts and the expenditure of significant funds to create customer awareness of and demand for our products. We cannot assure you that our new products will achieve significant market acceptance in the future or result in significantly increased levels of revenues.
In addition to the technical performance of our BioSentry and other products, the success of the BioSentry and other product lines is dependent in part on the Company’s estimates of the potential market for such systems. Because many of the expected markets for a detection system such as the BioSentry, as well as for the Company’s X-ray source-related products, do not presently exist, the Company has had to make a number of assumptions about the size and needs of such markets. As a result, the Company’s estimates about the size and nature of the expected markets for the BioSentry and other products may be inaccurate and the ultimate markets, and the actual sales of products into those markets, could be significantly less than the Company’s current estimates reflect. If the actual markets for the Company’s new products are not of the magnitude expected, or if they do not develop at the rate the Company expects, the Company’s revenues and financial condition will be adversely affected.
If our BioSentry business is unsuccessful, it will cause a significant adverse effect on our financial condition and significant accounting write-offs.
If our BioSentry business area is unsuccessful in the next several months in either selling significant numbers of BioSentry units or in obtaining significant additional financing or significant support from partnering arrangements, we will have to consider curtailing the BioSentry operations which would result in further reductions in BioSentry personnel and the write-down of a significant portion of the BioSentry assets.
We depend on third party suppliers of various components for our equipment business and our business will be harmed if the supply of key components is interrupted or discontinued.
Our Research Division, Vermont Operations, and our Sensor Products Group (BioSentry) are dependent 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 X-ray Nano Probe product requires 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. If we cannot obtain these complex 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.
The success of our business is dependent on our ability to compete effectively, particularly against larger, more established companies with greater resources.
The markets for our products are highly competitive and are characterized by rapid technological change and evolving industry standards. For example, although we are not aware of any products in the market for detecting and classifying microorganisms similar to our BioSentry product, water utilities and other water industry customers currently employ other products and technologies, such as filters and ultraviolet disinfection systems, to remove or neutralize microorganisms from the water supply. The X-ray Microscope and X-ray Nano Probe products provide alternative “soft” X-rays for the microscopy and materials processing markets. Currently, the intended users of soft X-rays must pay for time on large synchrotrons to perform their intended processes. Alternatively, for biological experimentation, other technologies are available, such as transmission electron microscopy, to perform the types of analyses performed by our new X-ray Microscope product. While we believe that our new X-ray products will provide certain functions that the current competitive products and technologies cannot provide (e.g., lower capital and operating expense; more rapid performance), there is a risk that our intended customers may not view these benefits as outweighing the features of established products and technologies (which include better resolution in the case of transmission electron microscopes or lower costs in the case of optical microscopes).
Further development by others of new or improved products, processes or technologies may make our products obsolete or less competitive. Our ability to compete is dependent on our ability to continually enhance and improve our products and to successfully develop and market new products. Many of our competitors have greater financial, managerial and technical resources than we have. We cannot assure you that we will successfully differentiate ourselves from our competitors, that the relevant markets will consider our products to be superior to our competitors’ products or that we will be able to adapt to evolving markets and technologies, develop new products or achieve and maintain technological advantages.
A substantial portion of our current revenue depends on sales to a few customers. We have relied on funding from the U.S. Department of Defense for a significant portion of our research and development activities in the past and expect significantly less funding of our new product developments from the government in the future.
To date, our CPL development program has received in excess of $62 million in funding under DARPA contracts over the past 10 years, with $3.5 million and $3.7 million received in 2005 and 2004, respectively. In 2006 and 2005, approximately 83 and 71 percent, respectively, of our revenues was derived as the prime contractor or subcontractor for two government contracts. One of the contracts is issued to our Research Division by the U.S. Army Research Laboratory sponsored by DARPA for further development of our CPL system (DARPA Contract). In February, 2005, we received the last $3.5 million in funding under the DARPA Contract. No further program funding related to the DARPA Contract is included in the United States Government’s budget and we expect no further funding under this contract after the receipt of the $3.5 million. We continue to receive funding from the Government under a separate DARPA/NAVAIR contract (NAVAIR Contract) for the procurement of X-ray masks. The funding for the NAVAIR Contract has been Congressionally mandated and is subject to the risk of losing Congressional support.
The DOD’s overall budget, and our participation therein, is subject to reduction 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 at similar levels in the future. The Company is relying on the sale of its new products in 2007 and beyond, together with financing transactions, which could include strategic alliances, to support continued product development and operations. To the extent we continue to invest in product development, these expenditures will increase our losses accordingly.
Until mid-2006, a major source of funding was the subcontract between JMAR’s Microelectronics Division (operated by JSI Microelectronics, Inc., a subsidiary of JMAR) 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. This work, which started in 1998, has resulted in a new subcontract each year out of funds available in the DMEA’s budget as an element of the Department of Defense’s Advanced Technology Support Program. The Company received $3.5 million in contracts in 2004 and $2.3 million in letter contracts in 2005. In February, 2006, the last of this funding was received and as of September 30, 2006, JSI Microelectronics, Inc. ceased operations.
Our BioSentry product may be subject to various governmental approvals that may limit our ability to market and sell our product.
In some cases, the use of our BioSentry product by the water utility industry, the commercial water bottling industry and others may require approval by governmental regulators prior to the commercial use of such units by our customers. In other cases, the acceptance of our BioSentry product may be enhanced by certification or other approvals by industry groups or government regulators. The failure to obtain approval of various state and federal agencies could adversely impact the sale of our BioSentry products
Our quarterly operating results may fluctuate significantly. As a result, we may fail to meet or exceed the expectations of securities analysts and investors, which could cause our stock price to decline.
Our quarterly revenues and operating results have fluctuated in the past and may continue to vary from quarter to quarter due to a number of factors, including the risk factors set forth in this section. If our operating results do not meet the expectations of securities analysts or investors, our stock price may decline.
If we lose key personnel or are unable to attract and retain additional, highly skilled personnel required for the expansion of our activities, our business will suffer.
In order to reduce costs, we have recently laid-off several employees and several key employees have resigned, including our Chief Financial Officer (who resigned to pursue other interests). Our success is substantially dependent on the efforts of certain key personnel. In particular, our nanotechnology product development efforts rely on the skill of several key laser and laser plasma scientists and engineers and our BioSentry product development effort relies on the skills of several key technical personnel in the areas of scattered-light-based detection systems, algorithms used to interpret the results of scattered light and microorganism morphology, as well as personnel experienced in the water industry. The loss of such personnel would adversely affect our business and prospects. In such event, we cannot assure you that we would be able to employ qualified persons on terms favorable to us. In seeking and retaining qualified personnel, we are required to compete with companies having greater financial and other resources than we have. Since our future success is dependent upon our ability to retain or attract qualified personnel, our failure to do so could have an adverse impact on our business.
Asserting, defending and maintaining intellectual property rights is difficult and costly and the failure to do so could harm our ability to compete and the results of our operations.
We rely, to a significant extent, on patents, trade secrets and confidentiality agreements to protect our proprietary technology. We cannot assure you as to the breadth or degree of protection which existing or future patents, if any, may afford us, or that patents will not be circumvented or invalidated, or that our products do not and will not infringe on patents or violate proprietary rights of others. In the event a patent infringement claim is asserted against us, or we are required to enforce our rights under an issued patent, the cost of such actions may be very high, whether or not we are successful. While we are unable to predict what such costs, if any, will be if we are obligated to pursue patent litigation, our ability to fund our operations and to pursue our business goals may be substantially impaired.
Our BioSentry product uses scattered light to detect particles in fluids. This field is the subject of substantial patent activity. We have entered into License Agreements with PointSource Technologies and The LXT Group, covering the license of technologies related to the BioSentry product area. Although JMAR believes that the patents and technology licenses from PointSource and LXT, as well as the technology that we have developed in-house, provide adequate coverage for our current BioSentry product, we can give you no assurances that the technologies that we want or need to use in the future in this field may not infringe on the patents or proprietary rights of others. If we need to use technologies owned by third parties in connection with our BioSentry products and cannot license them on reasonable terms, our ability to develop, manufacture and commercialize our BioSentry products will be adversely impacted, which would adversely affect our business and our stock price.
If our outstanding options and warrants are exercised and if our preferred stock is converted it will result in substantial dilution.
As of December 31, 2006, we had outstanding 39,535,615 shares of common stock. Substantially all of the outstanding shares of the Company’s common stock are freely tradable without restriction or further registration under the Securities Act. Affiliates may sell the shares they own pursuant to Rule 144, subject to certain notice filing and volume limitations.
As of December 31, 2006, there were 9,640,305 shares of common stock subject to issuance upon exercise of outstanding options and warrants. As of March 26, 2007, we had outstanding $7,850,000 stated value of Series G and I Convertible Preferred Stock. The outstanding Series G Preferred Stock is convertible into shares of common stock at $2.00 per share and the outstanding Series I Preferred Stock is convertible into shares of common stock at $1.16 per share. Subject to a contractual limitation on total beneficial ownership by Laurus to 9.99% of our common stock, the Series G and I Preferred Stock is convertible into 6,240,062 shares of Common Stock.
To the extent that outstanding options and warrants are exercised prior to their expiration dates, additional funds will be paid into us at the expense of dilution to the interests of our stockholders. Moreover, the terms upon which we will be able to obtain additional equity capital may be adversely affected since the holders of outstanding options and warrants and other securities can be expected to exercise or convert them at a time when we would, in all likelihood, be able to obtain any needed capital on terms more favorable to us than those provided in such securities. The sale of the shares issued upon exercise of our outstanding warrants and options and conversion of our Convertible Note and Preferred Stock could adversely affect the market price of our common stock.
If product liability claims are brought which exceed our liability insurance limits our business would be harmed.
We may be exposed to potential product liability claims arising out of the use of our products. Although we maintain product liability insurance on our current products, we cannot assure you that such insurance will be sufficient to cover potential claims or that the present level of coverage will be available in the future at a reasonable cost. A partially or completely uninsured successful claim against us could have a material adverse affect on our business. There can be no assurance that as we complete the commercialization and introduction of new products that insurance will be available on economically favorable terms or in amounts adequate to cover the risks associated with these new products.
We do not presently intend to pay cash dividends to our shareholders.
We have never paid cash dividends on our common stock and intend, for the foreseeable future, to retain our earnings, if any, to finance our business. Future dividend policy will depend on our earnings, capital requirements, financial condition, debt covenants and other factors considered relevant by our Board of Directors.
Our ability to use our entire net operating loss carryforward is limited by prior changes in ownership and may be further limited in the future.
We have federal net operating loss carry-forwards of approximately $62 million at December 31, 2006. These NOLs expire incrementally through 2026. Realization of future tax benefits from utilization of our net operating loss carry-forwards for income tax purposes is limited by changes in ownership in 1990, 1992 and 1993. Of the total NOLs, annual limitations of approximately $658,000 apply to approximately $2.5 million of the NOLs and the balance is subject to these annual limitations. In addition, the net operating losses of acquired companies are also subject to separate change of ownership limitations. Due to our taxable losses, we have been unable to take advantage of the benefits of these NOLs. The realization of the benefits of these NOLs is dependent upon our recognition of taxable income in the future prior to the expiration of the NOLs.
If we issue shares of preferred stock with greater rights than the common stock, it could result in the decrease in market price of the common stock and could delay or prevent a change in control of us.
Our Board of Directors is authorized to issue up to 5,000,000 shares of preferred stock, of which 785,000 shares of Series G and I Preferred Stock were outstanding as of March 26, 2007. As a result of prior issuances of a total of 1,450,000 shares of preferred stock
that were subsequently converted into common stock, a total of 2,765,000 shares of Preferred Stock are available for issuance in the future. Our Board of Directors has the power to establish the dividend rates, liquidation preferences, voting rights, redemption and conversion terms and privileges with respect to any series of preferred stock. The issuance of any shares of preferred stock having rights superior to those of the common stock may result in a decrease in the value or market price of the common stock. Holders of preferred stock may have the right to receive dividends, certain preferences in liquidation and conversion rights. The issuance of preferred stock could, under certain circumstances, have the effect of delaying, deferring or preventing a change in control of us without further vote or action by the stockholders and may adversely affect the voting and other rights of the holders of common stock.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
Item 2.
Item 2. PROPERTIES
The Company has a total of approximately 44,047 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, Research Division and Sensor Products Group lease 23,080 square feet of office, laboratory and storage space in a single facility in Northern San Diego County. That lease expires on October 31, 2012. In connection with its efforts to further reduce its costs, the Company is actively seeking to sublease a portion of this space.
JSI Microelectronics, Inc., which previously operated as the Company’s Microelectronics Division, leases 7,200 square feet of office and storage space in Sacramento, California. The original term of the lease was scheduled to expire on May 31, 2008. JSI Microelectronics, Inc. ceased operations as of September 30, 2006 and has vacated the premises. As a result, the landlord has commenced legal action against JSI Microelectronics to terminate the lease and obtain a judgment of the remaining rent under the lease.
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, 2008.
Item 3.
Item 3. LEGAL PROCEEDINGS
In March, 2007, MP Holdings, LLC commenced legal action against JSI Microelectronics, Inc., the Company’s wholly-owned subsidiary, to terminate the lease of the premises located in Sacramento County. Since JSI Microelectronics had already vacated the premises and has no material assets, no action is being taken to resist this legal action. JMAR Technologies, Inc. is not a guarantor on this lease and believes it has no legal responsibility for the obligations of JSI Microelectronics, Inc. JMAR has not been named in this lawsuit.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s common stock is traded on the OTC Bulletin Board under the symbol JMAR.OB. The 2006 and 2005 high and low transaction prices for the common stock as reported by NASDAQ (through December 22, 2006) and the OTC Bulletin Board (after December 22, 2006) are set forth in the following table.
Common Stock Price
As of March 19, 2007, there were approximately 10,285 beneficial owners of JMAR’s common stock and approximately 600 record holders. As of March 26, 2007, the Company’s common stock price was $0.23.
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.
Item 6.
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, Singer Lewak Greenbaum and Goldstein LLP for 2006 and Grant Thornton LLP for 2005, 2004, 2003 and 2002. 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 2005, 2004, 2003 and 2002 have been adjusted from that previously reported to reflect the operations of the Microelectronics Division as a discontinued operation.
Consolidated Statements of Operations Data - For the Years Ended December 31,
Consolidated Balance Sheet Data - December 31,
Item 7.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
JMAR Technologies, Inc. is an innovator in the development of laser-based technology and x-ray processes for nano-scale imaging, analysis and fabrication. The Company is leveraging more than a decade of laser and photonics research to develop a portfolio of nanotechnology products with commercial applications in rapidly growing industries, while continuing to carry out research and development for the U.S. Government.
JMAR’s pursuit of leading edge products targets nanotechnology, bioscience and the semiconductor industries with its BioSentry contamination warning system for waterborne microorganisms using laser-based, multi-angle light scattering technology, its BriteLight laser, a stand-alone product as well as the x-ray light source in nanolithography systems; the X-ray Microscope for 3D visualization of single cells and polymers; and the X-ray Nano Probe for enabling nano-scale interaction, analysis and materials modification. In addition, JMAR employs a key strategic alliance for the production of a hazardous materials chemical sensor, and the prototyping and production of a nanoparticle ultra-thin coating system.
A major source of revenue for the Company was 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 former McClellan Air Force Base in Sacramento for the DMEA (GDAIS Contract). This work, which started in 1998, resulted in a new subcontract each year out of funds available in the DMEA’s budget as an element of the Department of Defense’s Advanced Technology Support Program. The Company received $3.5 million in contracts in 2004, $2.3 million in letter contracts in 2005 and the final approximately $1.9 million against a $4.2 million contract finalized in February 2006. In March 2006, GDAIS informed the Company that DMEA desired to avoid the additional funding required to support the costs imposed by JMAR working under GDAIS as a subcontractor on the DMEA Contract and that the funding will only be sufficient for the prime contractor. Accordingly, JMAR will not receive additional subcontract funding from GDAIS. The viability of the Microelectronics Division was dependent on continued funding from GDAIS/DMEA. All work under the GDAIS Contract has been completed. Accordingly, the Company has reflected the Microelectronics Division as a discontinued operation for all periods included in this Form 10-K.
In early 2007, in order to remedy the problem of an operating cash shortfall, the Company held informal discussions with Laurus Master Fund LP (the holder of the Company’s Preferred Stock and the Company’s working capital lender) regarding additional financing. On February 27, 2007 JMAR formally requested a short term (four month) financing. Subject to terms that include warrants for a significant number of shares at a minimal exercise price and a requirement for JMAR to demonstrate a substantial reduction in its cash burn rate, on March 21, 2007, JMAR’s Board of Directors approved the proposed financing providing for a one year note for $750,000. The Company is currently negotiating a definitive agreement with Laurus for this financing which is anticipated to be completed in April, 2007. With regard to lowering the cash burn (net loss plus non-cash items), the Company has engaged in cost reduction efforts for the past six months resulting in a reduction from approximately $600,000 per month for most of 2006 to approximately $350,000 for March 2007. The Company intends to further reduce this rate through continued improvements. The cost reductions contributing to this improvement include salaries and benefits, consulting and legal fees, board fees, and IR&D project costs.
Sources of Revenue
Contract Research and Development, Technical Support, and Production Programs
The majority of the Company’s revenues have been derived as the prime contractor or subcontractor for two government contracts. These contracts have generated intellectual property owned by the Company in areas in which the Company believes there are significant commercial applications.
A contract issued to JMAR’s Vermont Operations by Naval Air Warfare Center AD, supports continued X-ray nanolithography technology and infrastructure development. Under this contract, JMAR procures sub-100 nm feature size X-ray masks used in the development and production of high-speed C-RAM with 50-35 nanometer features, enabling 16 megabyte and higher densities for high-priority military and space applications (NAVAIR Contract). A total of $15.5 million has been received under this contract, including $3.1 million funded in August 2006. The present total contract amount is $17.5 million, with incremental funding under the contract sought on an annual basis.
The U.S. Army Research Laboratory contract sponsored by DARPA and issued to JMAR’s Research Division has facilitated development of the Company’s Collimated Plasma Lithography (CPL) system (DARPA Contract). A total of $23.7 million has been received under this contract since 2001, including $3.5 million funded in February 2005 (the receipt of funding allows the Company to bill for costs incurred, plus a portion of Company overhead expenses). No program funding related to the DARPA Contract is included in the United States Government’s current fiscal year budget and the Company expects no further funding under this contract.
Standard Products
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 Korea and at the Lawrence Livermore National Laboratory. JMAR is carrying out manufacturing engineering to reduce production costs and to expand the addressable market for this high performance laser.
The Company has developed and is marketing and selling its BioSentry sensor for continuous, on line, real-time monitoring of drinking water for the presence of microorganisms. JMAR has received a number of orders for a small number of units from commercial and government customers, including a beverage company, a cruise line and several water utility, municipal and federal agencies. Additional resources for further product development, marketing and distribution are necessary in order to take advantage of the potential markets for the BioSentry. If the Company is unsuccessful in the next several months in either selling significant units, obtaining additional financing or obtaining the support of strategic or financial partners, it will need to consider curtailing its support of the BioSentry business area.
New Products Under Development
JMAR has identified commercial opportunities for instruments enabled by the laser and soft X-ray generator technology developed by the Company over the past decade in pursuit of CPL. Advanced nanolithography as well as the compact X-ray Nano Probe product is under development and targeted at large addressable markets. JMAR’s resources for new product development are currently extremely limited and JMAR will continue to pursue government funding to support JMAR’s soft X-ray based new product development efforts. The lack of success in obtaining such funding will result in a decrease in the further development of this technology.
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 “Risk Factors” in Item 1A above for more information on the risks and uncertainties faced by JMAR.
Results of Operations
Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
Revenues. Total revenues for the years ended December 31, 2006 and 2005 were $4,857,092 and $5,764,252, respectively, the majority of which were contract revenues. Revenues for 2006 and 2005 were as follows:
The decrease in revenues for the year ended December 31, 2006 compared to the year ended December 31, 2005 was primarily attributable to a decrease of $732,150 related to the READ program, $362,259 related to BriteLight sales and $138,278 related to the DARPA Contract. The decrease in the DARPA Contract in 2006 is because the last funding on that contract was received in February 2005 and the decrease in READ program revenues is due to the completion in 2006 of the 2 Alphas and 3 Betas for that program. These decreases were offset in part by an increase in NAVAIR revenues of $317,665.
Losses. The net loss for the years ended December 31, 2006 and 2005 was $(13,106,681) and $(8,032,803), respectively. The loss from continuing operations for those same periods was $(12,853,885) and $(7,837,031), respectively, while the loss from operations for those same periods was $(12,483,413) and $(7,751,025), respectively. Included in the net loss for 2006 is a write-down of goodwill of $4,415,932. Included in the net loss for the years ended December 31, 2006 and 2005 are costs invested in product development (see further discussion below) of $2,703,257 and $3,049,439, respectively, a loss from discontinued operations of $252,796 and $195,772, respectively, and asset writedowns of $87,845 and $161,174, respectively. In addition, for 2006, as a result of the adoption of SFAS No. 123(R) on January 1, 2006, there is a non-cash compensation charge of $354,981, and the Company recorded an accounts receivable reserve of $428,067.
Gross Margins. Gross margins for the fiscal years ended December 31, 2006 and 2005 were 8.7% and 28.2%, respectively. The decrease in the gross margin for the year ended December 31, 2006 compared to the prior year is primarily due to the commercial sale in 2005 of a BriteLight system by the Research Division, additional costs incurred in 2006 related to the READ product due to delays in the completion of the Alpha and Beta units, higher subcontract and material costs on the NAVAIR Contract and higher unabsorbed overhead due to lower revenues and factory underutilization due to the completion of the READ Alpha and Beta program and delays in BioSentry revenues.
Selling, General and Administrative (SG&A). SG&A expenses for the fiscal years ended December 31, 2006 and 2005 were $5,698,745 and $6,166,124, respectively. The decrease in SG&A expenses for 2006 was primarily attributable to overall cost reductions and lower rent expense in 2006 compared to 2005. Partially offsetting these reductions was an accounts receivable reserve of $428,067 and a non-cash compensation charge of $292,746 related to SFAS No. 123(R).
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.
Total RD&E expenditures for 2006 and 2005 were $6,275,741 and $5,926,451, respectively. Total RD&E expenditures as a percentage of revenues were 129% and 103% for the years ended December 31, 2006 and 2005, 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 and the Company-funded RD&E costs have increased as a result of the Company’s commercialization efforts.
Goodwill Write-off. The goodwill write-off in 2006 of $4,415,932 relates to the goodwill of the Research Division/Vermont Operations reporting unit. The write-off was based on an analysis performed in February 2007 in accordance with FASB Statement No. 142 (see Critical Accounting Policies and Estimates). Impacting the analysis was the Company’s low market capitalization due to its reduced stock price. In addition, the discounted cash flow analysis was impacted by the agreement reached with a leading microscopy company whereby the Company sold its XRM technology in exchange for an up front cash payment and future royalties and was appointed exclusive laser supplier for the XRM. In addition, based on the status of the Company’s BioSentry partner search initiated in June 2006, for purposes of the goodwill analysis, the assumption was that BioSentry manufacturing will be outsourced at some time in the future. In addition, due to its current financial situation, JMAR’s ability to finance the development, commercialization and sale of its products has been impacted, thereby delaying the development and commercialization of the Company’s products.
Discontinued Operations. The loss from operations of discontinued operations of $252,796 and $195,772 for the years ended December 31, 2006 and 2005 is related to the Microelectronics Division and in 2006 includes an expense of $127,911 for assets to be disposed and $262,246 related to leases of the Microelectronics Division, primarily the facility lease, based on an appropriate discount rate.
Until mid-2006, a major source of revenue for the Company was the subcontract between JMAR’s Microelectronics Division (operated by JSI Microelectronics, Inc., a subsidiary of JMAR) and the General Dynamics Advanced Information Systems (GDAIS) to enhance and maintain the semiconductor wafer fabrication processes installed at the former McClellan Air Force Base in Sacramento for the DMEA (GDAIS Contract). This work, which started in 1998, resulted in a new subcontract each year out of funds available in the DMEA’s budget as an element of the Department of Defense’s Advanced Technology Support Program. The Company received $3.5 million in contracts in 2004, $2.3 million in letter contracts in 2005 and the final approximately $1.9 million against a $4.2 million contract finalized in February 2006. In March 2006, GDAIS informed the Company that DMEA desired to avoid the additional funding required to support the costs imposed by JMAR working under GDAIS as a subcontractor on the DMEA Contract and that the funding will only be sufficient for the prime contractor. Accordingly, JMAR will not receive additional subcontract funding from GDAIS. The viability of the Microelectronics Division was dependent on continued funding from GDAIS/DMEA. All work under the GDAIS Contract was substantially completed in 2006. Accordingly, the Company has reflected the Microelectronics Division as a discontinued operation for all periods included in this Form 10-K.
Interest and Other Expense. Interest and other expense for the years ended December 31, 2006 and 2005 was $423,565 and $257,527, respectively. Interest expense is higher for 2006 versus 2005 due to the utilization of the Company’s Working Capital Line and increase in the interest rate on the Working Capital Line. Included in interest expense for the years ended December 31, 2006 and 2005 is $256,169 and $206,821, 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.
Preferred Stock Dividends. Included in the loss applicable to common stockholders in the Consolidated Statements of Operations for the years ended December 31, 2006 and 2005 are preferred stock dividends of $1,283,668 and $2,091,232, respectively. The preferred stock dividend amounts for the years ended December 31, 2006 and 2005 consist of $633,451 and $571,529, respectively, of preferred stock dividends paid or payable in cash and $650,217 and $1,139,206, respectively, related to the discount representing the beneficial conversion feature of the redeemable convertible preferred stock, the fair value of warrants issued in connection with the preferred stock and the difference between the fair value of the preferred stock immediately prior to and after the 2005 Amendment (see page 26). In addition, the amount for 2006 includes the difference between the fair value of the preferred stock immediately prior to and after the 2006 Amendment (see page 26) and the 2005 amount includes $380,497 related to the excess of the fair value of the consideration issued by the Company for the redemption of the Series E Preferred Stock over its carrying amount.
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Revenues. Total revenues for the years ended December 31, 2005 and 2004 were $5,764,252 and $6,361,562, respectively, the majority of which were contract revenues. Revenues for 2005 and 2004 were as follows:
The decrease in revenues for the year ended December 31, 2005 compared to the year ended December 31, 2004 was primarily attributable to a decrease of $2,882,171 in revenues related to the DARPA Contract and a decrease of $358,847 related to two contracts completed in 2004 at the Vermont Operations. Offsetting these declines were an increase of $1,766,829 in revenues of the NAVAIR Contract and sales of $592,570 for two BriteLight systems. The lower revenues for the DARPA Contract in 2005 is related to the fact that no additional funding related to the DARPA Contract was included in the U.S. Government fiscal year 2005 budget and no further funding on this contract is expected beyond the funds received in February 2005. The NAVAIR Contract revenues are higher in 2005 due to funding received later in 2004.
Losses. The net loss for the years ended December 31, 2005 and 2004 was $(8,032,803) and $(5,632,140), respectively. The loss from continuing operations for those same periods was $(7,837,031) and $(5,692,427), respectively, while the loss from operations for those same periods was $(7,751,025) and $(4,986,325), respectively. Included in the net loss for the years ended December 31, 2005 and 2004 are costs invested in product development (see further discussion below) of $3,049,439 and $1,642,781, respectively, a loss from discontinued operations of $195,772 in 2005 and a gain of $60,287 in 2004, and a non-cash interest charge of $206,821 and $442,029, respectively (see “Interest and Other Expenses” below). Also included in the net loss for the years ended December 31, 2005 and 2004 are asset writedowns of $161,174 and $191,575, respectively.
Gross Margins. Gross margins for the fiscal years ended December 31, 2005 and 2004 were 28.2% and 20.2%, respectively. The Company’s margins are low because the majority of its revenues are from contract revenues, which inherently generate lower margins than product revenues. The primary increase in the gross margin for the year ended December 31, 2005 compared to the prior year is due to the commercial sale of a BriteLight system by the Research Division in the first quarter and a contract reserve of approximately $316,000 for the year ended December 31, 2004 related to reserves on a contract at the Vermont Operations and inventory reserves of approximately $168,000 also at the Vermont Operations.
Selling, General and Administrative (SG&A). SG&A expenses for the fiscal years ended December 31, 2005 and 2004 were $6,166,124 and $4,435,586, respectively. The increase in SG&A expenses for 2005 was primarily attributable to higher SG&A costs of the Sensor Products Group formed in the quarter ended June 30, 2004 of approximately $1,252,000, higher rent of approximately $179,000, higher accounting fees of approximately $132,000 and higher legal costs of approximately $131,000. The increase for 2005 was offset in part by lower intangible amortization at the Vermont Operations of approximately $153,000 due to an intangible that became fully amortized in 2004.
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.
Total RD&E expenditures for 2005 and 2004 were $5,926,451 and $5,636,643, respectively. Total RD&E expenditures as a percentage of revenues were 103% and 89% for the years ended December 31, 2005 and 2004, respectively. The RD&E expenditures as a percentage of revenues have been historically higher than that for a commercially oriented company because much of the Company’s revenues have been R&D contract revenues. In addition, in 2005 and 2004, the Company’s revenues have been declining and the Company-funded RD&E costs have increased as a result of the Company’s commercialization efforts.
Discontinued Operations. The loss from operations of discontinued operations of $195,772 for the year ended December 31, 2005 is related to the Microelectronics Division. The gain from operations of discontinued operations of $60,287 for the year ended December 31, 2004 includes income of $275,180 related to the Microelectronics Division and a loss of $214,893 related to the standard semiconductor products business, primarily associated with the lease of the Irvine facility. Prior to December 31, 2001, as the level of business expected from its standard semiconductor products business did not materialize, the Company decided to take action to sublease its Irvine facility and move the standard semiconductor products business into a smaller facility and recorded a reserve against the Irvine facility lease. Subsequently, this business was discontinued. The lease provided for rent and related expenses of approximately $36,000 per month through August 2005. In June 2004, the Company subleased the facility; however, the subtenant defaulted on the sublease in January 2005. The lease expired in August 2005.
Interest and Other Expense. Interest and other expense for the years ended December 31, 2005 and 2004 was $257,527 and $821,586, respectively. Interest and other expense is lower for 2005 versus 2004 primarily due to conversions of the Company’s Working Capital Line into common stock in the first quarter of 2004 which resulted in an acceleration of amortization of the discount related to the beneficial conversion feature and fair value of warrants issued in connection with the Working Capital Line. Included in interest expense for the years ended December 31, 2005 and 2004 is $206,821 and $442,029, 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.
Preferred Stock Dividends. Included in the loss applicable to common stockholders in the Consolidated Statements of Operations for the years ended December 31, 2005 and 2004 are preferred stock dividends of $2,091,232 and $2,247,876, respectively. The preferred stock dividend amounts for the years ended December 31, 2005 and 2004 consist of $571,529 and $341,372, respectively, of preferred stock dividends paid or payable in cash and $1,139,206 and $1,906,504, respectively, related to the discount representing the beneficial conversion feature of the redeemable convertible preferred stock, the fair value of warrants issued in connection with the preferred stock and the difference between the fair value of the preferred stock immediately prior to and after the 2005 Amendment. In addition, the 2005 amount includes $380,497 related to the excess of the fair value of the consideration issued by the Company for the redemption of the Series E Preferred Stock over its carrying amount.
Liquidity and Financial Condition
General. Cash and cash equivalents at December 31, 2006 was $696,546. In 2006 and 2005, we funded our operations primarily from the sale of preferred and common stock. The decrease in cash and cash equivalents during the year ended December 31, 2006 of $4,583,145 resulted primarily from cash used in operations of $6,595,411 (primarily related to operating losses, an increase in prepaid expenses and other, and a decrease in accounts payable and accrued liabilities offset in part by changes in net assets and liabilities of discontinued operations and an increase in billings in excess of costs incurred) and payment of preferred stock dividends of $633,451, offset in part by net proceeds from the issuance of common stock of $1,334,413 and net borrowings under line of credit of $1,422,428.
Working capital (deficit) as of December 31, 2006 and 2005 was $(2,657,725) and $4,036,601, respectively. The decrease in working capital is primarily due to the Company’s losses and payment of preferred stock dividends, offset in part by gross proceeds from the issuance of common stock of approximately $1.4 million.
Our cash requirements have been and will continue to be significant. JMAR’s operations will continue to use cash in 2007 for 1) product development efforts; 2) corporate costs, primarily related to the cost of being a public company; 3) preferred stock redemptions and dividends; and 4) other working capital needs. The Company has determined that it will require additional financing for working capital requirements, as well as to complete or accelerate the development of some of its emerging new products . These financing efforts could include the sale of equity, obtaining funds in connection with our previously announced search for a partner or investor related to the BioSentry business, or from the sale or licensing of other products of the Company. See further discussion in footnote 1 in the accompanying Notes to Consolidated Financial Statements and “Risk Factors” in Item 1A above. If the Company is successful in promptly completing a $750,000 debt financing which has been presented by Laurus Master Fund to the Company and has been approved by the Company’s Board of Directors, management believes that the Company will have adequate resources to fund working capital requirements and product development through June 30, 2007. Management is engaged in several initiatives to secure financing beyond June 30, 2007.
Sales of Common Stock. In the first quarter of 2007, JMAR entered into Securities Purchase Agreements and completed the sale of $386,682 of the Company’s common stock to Laurus. Pursuant to the Securities Purchase Agreements, the Company issued a total of 2,254,467 shares of common stock.
On February 1, 2005, the Company entered into a Securities Purchase Agreement and completed the sale of $4 million of the Company’s common stock and warrants to five institutional investors (February 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 February Investors. The warrants have an exercise price of $1.73 per share and a term of five years. After expenses of the transaction and the advisor’s fee, the Company received net proceeds of approximately $3,852,000.
As a result of the completion of the February 2005 Offering, the PointSource Investors (see “License Agreements”, below) were offered the right to purchase a total of 53,548 shares of common stock (Additional Shares) and warrants to purchase 20,081 shares of common stock with an exercise price of $1.73 per share (Additional Warrants) for a total purchase price of $66,400. In mid-February, 2005, the PointSource Investors purchased the Additional Shares and Additional Warrants for $66,400.
On December 28, 2005 and January 4, 2006, the Company entered into Securities Purchase Agreements and completed the sale of $3.63 million of the Company’s common stock and warrants to nine institutional investors and four accredited individual investors (December Investors). Pursuant to the Securities Purchase Agreements, the Company issued a total of 3,025,001 shares of common stock and warrants to purchase 2,117,501 shares of common stock to the December Investors. The warrants have an exercise price of $1.44 per share and a term of five and one-half years. After expenses of the transaction and the advisor’s fee, the Company received net proceeds of approximately $3.4 million, of which approximately $1.4 million was received after December 31, 2005 and, accordingly, is not included in the Company’s cash and cash equivalents of $5,279,691 at December 31, 2005.
Issuances of Preferred Stock. 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 (2005 Amendments). As discussed below, the Series E was fully redeemed at the end of 2005 and the Series F-H were further amended in 2006. The 2005 Amendments provided for, among other things, 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 plus a 2% fee) for the Series E Preferred Stock were deferred and due in full in 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 plus a 2% fee) were deferred until February, 2007; and 2) 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. Pursuant to the 2005 Amendments, the $150,000 in monthly redemption payments under the Series F-H Preferred Stock was scheduled to recommence in August, 2006 and continues 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 would be reduced to the extent that there were conversions of the Preferred Stock into common stock.
On December 22, 2005, the Company entered into a Securities Purchase Agreement with Laurus whereby in exchange for and in complete cancellation (Redemption) of all of the remaining $1,000,000 of Series E Preferred Stock, the Company issued 1,041,667 shares of the Company’s common stock, valued at a discount to the closing stock price of the Company on December 19, 2005. In addition, the Company issued a warrant for the purchase of 375,000 shares of common stock, with an exercise price of $1.50, based on 125% of the closing price of the Company’s common stock on December 19, 2005. The warrant is not exercisable for the first six months and has a term of five years. Prior to the Redemption, the Series E Preferred Stock was redeemable in full in the amount of $1,000,000 in July 2006, if not previously converted to common stock.
On March 28, 2006, the Company issued a new Series I Convertible Preferred Stock to replace $6,393,980 of the Series F-H Convertible Preferred Stock, leaving $1,456,020 of the Series G Preferred Stock outstanding. The parties also amended the remaining redemption schedule of the Series G Preferred Stock (the issuance of the Series I and the amendments to the Series G are referred to below as the 2006 Amendments). The 2006 Amendments have the effect of deferring the $7,850,000 in redemption payments, as follows: a) 6 monthly redemption payments originally commencing August 2006 ($150,000 per month plus a 2% fee) are deferred one year and reduced to $122,178 per month; b) $6,588,314 of the redemption payment originally due February 2007 is deferred until August 2008; and c) the remaining $528,618 is payable at $27,822 per month starting February 2007 through August 2008. The conversion price for the $6,393,980 of the Series F-H Preferred Stock was originally $2.00, while the new $6,393,980 of Series I Preferred Stock has a conversion price of $1.16 per share. In addition, the exercise price (originally ranging from $3.42 to $3.82) of the warrants exercisable into 200,000 shares originally issued in connection with the Series F-H Preferred Stock was reduced to $1.16. The redemption payments will be reduced to the extent that there are conversions of the Preferred Stock into common stock. The rights and privileges of the Series I Preferred Stock are the same as the Series F-H Preferred Stock, other than the conversion price and redemption payments.
In connection with all of the above financing transactions with Laurus, including the prior issuances of Series A-D Preferred Stock in 2003 and the Working Capital Line, the Company issued warrants to Laurus to purchase a total of 1,786,375 shares of common stock at prices ranging from $1.058 to $5.15. In addition, in connection with the 2006 Working Capital Line on March 28, 2006 Laurus was granted two warrants to purchase up to 458,181 shares of common stock (based on the level of indebtedness under the line) at an exercise price of $0.01 per share. As of March 26, 2007 all of the preferred stock and warrants held by Laurus is convertible or exercisable into approximately 9.1 million shares.
If not previously converted to common stock, the outstanding amount of Series G and I 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”).
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, except for the warrants to purchase up to 458,181 shares of common stock described above.
Working Capital Line. In March 2003, the Company entered into a Revolving Fixed Price Convertible Note (Working Capital Line) with Laurus. The term of the Working Capital Line expired on March 21, 2006 and was replaced by a new line of credit facility (see below). The Working Capital Line allowed 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 were allowed, however, with the consent of Laurus. Laurus could 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 was in excess of the Conversion Price. The Company could convert a portion of the principal outstanding to common stock at the Conversion Price if the market price of the Company’s common stock averaged 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 was equal to the prime rate plus 0.75 percent, subject to a floor of 5.00 percent. The Working Capital Line required that the Company’s quick ratio, as defined, be 0.90 or higher. The quick ratio was defined as the sum of cash and accounts receivable divided by the sum of current liabilities, exclusive of current liabilities of discontinued operations.
On March 28, 2006, the Company and Laurus replaced the expiring Working Capital Line with the 2006 Working Capital Line. The 2006 Working Capital Line allows the Company to borrow from time-to-time up to 90% of eligible accounts receivable and up to 50% of eligible inventory up to $500,000, up to an aggregate maximum of $3 million. The 2006 Working Capital Line is non-convertible and has no financial ratio covenants. The interest rate on the 2006 Working Capital Line is equal to the prime rate (8.25% at December 31, 2006) plus 2 percent. Accrued interest is payable monthly. Upon approval of Laurus, the 2006 Working Capital Line provides for advances in excess of the availability (Overadvance). The available borrowings under the 2006 Working Capital Line were approximately $922,000 at December 31, 2006, all of which was borrowed and outstanding at December 31, 2006. In addition, at December 31, 2006, an Overadvance of $500,000 was outstanding. The 2006 Working Capital Line terminates in March 2008.
JMAR’s obligations under the Working Capital Line are secured by a security interest in all of JMAR’s assets. Upon a default by JMAR under the Working Capital Line, Laurus would have the right to foreclose on the Company’s assets and sell those assets to repay the outstanding balance of the Working Capital Line and related costs. In addition, the Company’s obligations under the Preferred Stock, including its obligations to make dividend payments and to make regular payments in redemption of the Preferred Stock, are also secured by this blanket security interest.
Sale of XRM Assets. In March 2007, the Company entered into an agreement with a leading microscopy company under which JMAR sold the assets of its XRM product. Among other provisions, under the agreement JMAR received an initial payment of $100,000 and reimbursement of up to $50,000 in costs, an additional payment of $500,000 once the XRM is operational at the acquirer’s facility, expected to be in April 2007, another $100,000 upon satisfaction of certain performance criteria and a four year royalty based on the sale of XRM units by the other party. JMAR was also appointed exclusive laser supplier to the other party for the same four year period.
Letter of Credit. In connection with the Company’s lease of its Rancho Bernardo facility, Comerica Bank (Comerica) issued a letter of credit in the amount of $128,645. If the Company’s cash in its accounts with Comerica fell below $1 million at the end of any quarter, Comerica required that the Company set aside the amount of the letter of credit. Although the Company’s cash was less than $1 million as of December 31, 2006, the Company has not yet pledged $128,645 of its cash to Comerica. Comerica has orally agreed to accept a pledge of $39,322.50 of the Company’s cash upon the Company’s receipt of the $750,000 financing discussed above and another $39,322.50 in September 2007 shortly before the amount of the required letter of credit reduces to $78,645.
Cash Used in Operations. Cash used in operations was $6,595,411 in 2006 compared to $4,806,376 in 2005. The loss from operations net of non-cash items (depreciation, amortization, debt discount, services received in exchange for common stock or warrants and asset write-downs) was $7,089,846 and $7,270,324 in 2006 and 2005, respectively. The lower use of cash related to the loss from operations net of non-cash items in 2006 is primarily due to lower SG&A and RD&E expenses in 2006 of $467,379 and $346,182, respectively, partially offset by lower gross profit in 2006 compared to 2005 of $1,203,346. Adversely impacting cash flow from operations in 2006 was an increase in prepaid expenses and other of $318,312 and a decrease in accounts payable and accruals of $287,123 and positively impacting cash flow from operations was an increase in billings in excess of costs incurred of $795,907 and a change in net assets and liabilities of discontinued operations of $942,171. Helping cash flow from operations for 2005 was a decrease in accounts receivable of $1,084,680 primarily related to the receipt of $3,508,000 in funding on the DARPA Contract in February 2005. Also helping cash flow from operations in 2005 was the receipt of $346,000 in lease incentives from a landlord associated with the lease of a facility in 2005, an increase in accounts payable and accrued liabilities of $535,879 and a decrease in prepaid expenses and other assets of $588,107.
Cash Used in Investing Activities. In 2006, cash used in investing activities was $111,124 compared to $1,380,586 in 2005. The lower amount in 2006 is primarily due to a reduction in capital expenditures due to non-recurring costs incurred in 2005 related to the consolidation and expansion of its three San Diego facilities into one location and the implementation of a new ERP system in 2005, and capital expenditures of discontinued operations of $301,927.
Cash Provided by Financing Activities. In 2006, cash provided by financing activities was $2,123,390 compared to $4,910,961 in 2005. Net proceeds from the sale of common stock were $1,334,413 and $5,813,653 in 2006 and 2005, respectively. During 2005, the Company made preferred stock redemptions of $233,333 (see preferred stock Amendments discussed above). Preferred stock dividends in 2006 and 2005 was $633,451 and $669,359, respectively.
Commitments
Future minimum annual commitments under contractual obligations, net of sublease income, and deferred compensation as of December 31, 2006 are as follows:
The leases are primarily for facilities. The deferred compensation is presented at the total amount to be paid, whereas the liability has been discounted for financial reporting purposes.
Preferred Stock Redemption Obligations
Excluded from the above table are redemption obligations under Series G and I Preferred Stock. If not previously converted, the Series G and I Preferred Stock must be redeemed by the Company as follows:
Line of Credit
On March 28, 2006, the Company and Laurus entered into a new Working Capital Line (2006 Working Capital Line). The 2006 Working Capital Line allows the Company to borrow from time-to-time up to 90% of eligible accounts receivable and up to 50% of eligible inventory up to $500,000, up to an aggregate maximum of $3 million. Upon approval of Laurus, the 2006 Working Capital Line provides for advances in excess of the availability (Overadvance). The 2006 Working Capital Line is non-convertible and has no financial ratio covenants. The interest rate on the 2006 Working Capital Line is equal to the prime rate plus 2 percent. The 2006 Working Capital Line terminates in March 2008. As of December 31, 2006 there was $1,422,428 outstanding under the 2006 Working Capital Line, including a $500,000 Overadvance, all of which is included in current liabilities on the accompanying Consolidated Balance Sheet and which is excluded from the above table.
License Agreements
In January 2005, JMAR and PointSource Technologies, LLC (PointSource) entered into a License Agreement granting the Company an exclusive license covering all PointSource patents and other intellectual property related to the manufacture and sale of scattered-radiation-based products used to detect or classify microorganisms in water and other media. Pursuant to the License Agreement, PointSource also sold substantially all of its laboratory and engineering room equipment to the Company. The License Agreement provides for the payment by JMAR of a royalty of 2.5% of the net sales of certain “licensed products” for a six year period, with the right to reduce the royalty to 1.25% after four years if we are no longer using the PointSource technology. The “Licensed Products” consist of any scattered-radiation-based products used to detect or classify microorganisms in water (including our BioSentry product) and any other product that is within the scope of the licensed PointSource patents. As additional consideration for the License Agreement, we also entered into a Securities Purchase Agreement providing for the issuance to PointSource of
520,000 shares of common stock (PointSource Shares) and warrants (PointSource Warrants) to purchase 333,333 shares of common stock (PointSource Warrant Shares), with an exercise price of $1.38 per share, and a term of 5 years. PointSource was also granted the right to purchase additional shares in an amount equal to 1.66% of the shares sold in certain subsequent issuances by us on the same terms as such issuance. PointSource subsequently assigned this additional purchase right to its affiliates (PointSource Investors), together with 500,000 of the PointSource Shares and all of the PointSource Warrants. This purchase right expired in July 2006. The PointSource Investors exercised this purchase right as it related to the February 1, 2005 offering and purchased 53,548 shares of common stock and warrants to purchase 20,081 shares of common stock with an exercise price of $1.73.
On February 21, 2005, JMAR and LXT executed a Technology Transfer and License Agreement (License Agreement) with Gregory Quist and David Drake, dba The LXT Group (LXT Group). The License Agreement provides for the transfer to JMAR of certain trademarks and rights to certain designs and data related to the BioSentry product, plus the grant of an exclusive, perpetual, worldwide license by LXT to JMAR to use certain technology covered in a pending utility patent application filed by LXT in January, 2005 with the United States Patent & Trademark Office entitled “Continuous On-Line Real-Time Surveillance System.” The scope of this license is limited to the use of light scattering for detection of microorganism contamination and other particles in water. In consideration for the transfer of the rights and license of the technology described above, JMAR agreed to pay LXT a royalty equal to two percent (2%) of the gross revenue of any nature arising from the BioSentry system used for the detection of microorganisms in water regardless of the technology employed, commencing on the date JMAR receives the first dollar of BioSentry revenue (Revenue Start Date) and continuing until the seventh anniversary thereof. The royalty payments are payable on a quarterly basis within 45 days after the end of each quarter. The License Agreement also modified an outstanding $125,000 loan to the LXT Group 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 accrues interest at the “prime rate” until satisfied or discharged.
On February 10, 2006, JMAR and Colorado State University Research Foundation (CSURF) as agent for Colorado State University entered into a License Agreement for the use of CSURF’s discharge pumped soft X-ray laser technology, developed under the auspices of the National Science Foundation’s Engineering Research Center for Extreme Ultraviolet Science and Technology. The laser produces high-intensity radiation at a wavelength shorter than any other laser on the market today and complements JMAR’s Laser Produced Plasma X-ray source that produces shorter wavelengths still. The License Agreement calls for an up-front payment of $10,000; a royalty of 3% of net sales for the first $1 million in net sales and then 2% thereafter; and a minimum annual royalty of $10,000 starting for calendar years after the year in which the first commercial sales are made. In addition, as part of the License Agreement, the Company agreed to enter into a sponsored research agreement with CSURF valued at $64,000 to demonstrate the applicability of the technology as a nanoprobe source.
Net Operating Loss Carryforward
At December 31, 2006, the Company had approximately $62 million of Federal net operating loss carryforwards subject to certain annual limitations, which expire from 2007 through 2026. 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, accounts receivable, 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, 2006, 2005 and 2004, over 90% of the Company’s revenues were contract revenues, with the remainder consisting of two BriteLight sales, BioSentry revenues, 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. As appropriate, the program manager prepares a statement of work, schedule and budget for each contract. At least quarterly, actual costs are compared to budget and technical progress is compared to the planned schedule. The Company prepares an estimate of costs to complete for each contract at least quarterly. Estimated losses based on this review are fully charged to operations when identified. Actual costs could differ from these estimated costs. Reimbursable or recoverable general and administrative (G&A) costs are charged to G&A expense as incurred.
Goodwill and Intangible Assets
In accordance with FASB Statement No. 142, “Goodwill and Other Intangible Assets,” effective January 1, 2002, the Company has established reporting units and applies a two-step fair value approach to evaluating goodwill impairment, using at least an annual assessment. The Company compares the fair value of the business unit with the carrying amount of the assets associated with the business unit. The fair value of each business unit is determined using a risk adjusted discount rate to compute a net present value of estimated future cash flows and a consideration of market capitalization of the Company. The second step measures the amount of the impairment, if any.
Management performed an interim evaluation of goodwill as of June 30, 2004 following notification that no additional funding of the DARPA Contract was included in the Government’s fiscal year 2005 budget. A further evaluation of goodwill was performed again as of December 31, 2004, December 31, 2005, June 30, 2006 and December 31, 2006. Until September 30, 2006, the business units identified were Vermont Operations/Research Division, Microelectronics Division and Sensor Products Group. With the discontinuance of the Microelectronics Division, the Company now has two business units. 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 development and commercialization, with the source and technology development coming from the Research Division and the product design, manufacturing engineering, integration, testing and assembly performed by the Vermont Operations, as well as the zone plate optics development and manufacturing for the future laser based products to be performed by the Vermont Operations). Additionally, the Vermont Operations will use its core capabilities to perform manufacturing for other products of the Company.
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 in the future based on its current knowledge of the market and our expectations of successfully penetrating those markets.
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 two 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).
Based on the Company’s analysis as of December 31, 2006, the entire amount of goodwill of $4,415,932 was written off.
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.
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.
Allowances for Doubtful Accounts
JMAR maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of JMAR’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Management reviews delinquent accounts at least quarterly to identify potential doubtful accounts, and together with customer follow-up estimates the amounts of potential losses.
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 Expense
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R), using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, the Company recognizes compensation expense for all stock options granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). Prior to the adoption of SFAS No. 123(R) on January 1, 2006, the Company recognized stock-based compensation expense in accordance with APB No. 25, and provided proforma disclosure in accordance with SFAS No. 123, as if the fair value method defined by SFAS No. 123 had been applied to its stock-based compensation. Under the fair value recognition provisions of SFAS No. 123(R), the Company recognizes stock-based compensation expense for those shares expected to vest on a straight-line basis over the requisite service period of the award.
The Company uses the Black Scholes option valuation model to estimate the fair value of its stock options at the date of grant. The Company uses historical data to estimate the expected price volatility, the expected option life and the expected forfeiture rate. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option. Determining the appropriate fair value model and calculating the fair value of share-based payment awards requires the input of subjective assumptions. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. See Note 12 to the Consolidated Financial Statements for a further discussion of stock-based compensation.
Recent Accounting Pronouncements
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 108 to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires that registrants quantify the impact on the current year’s financial statements of correcting all misstatements, including the carryover and reversing effects of prior years’ misstatements, as well as the effects of errors arising in the current year, SAB 108 is effective as of the first fiscal year ending after November 15, 2006, allowing a one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006, for errors that were not previously deemed material, but are material under the guidance in SAB No. 108. There was no impact on our consolidated financial statements with respect to the adoption of SAB NO. 108.
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 SFAS No. 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 the production facilities. The adoption of SFAS No. 151 did not have a significant effect on the Company’s consolidated financial statements.
In May 2005, the FASB issued FASB Statement No. 154, “Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3” (SFAS No. 154). This Statement changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to
changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Therefore, we have adopted the provisions of SFAS No. 154 for our fiscal year beginning January 1, 2006 as applicable. The adoption of the provisions of SFAS No. 154 did not have a material impact on our consolidated financial statements.
In October 2005, the FASB issued FSP FAS 13-1, “Accounting for Rental Costs Incurred during a Construction Period”, which addresses the accounting for rental costs associated with operating leases that are incurred during a construction period. This FSP requires that rental costs associated with ground or building operating leases incurred during a construction period be recognized as rental expense and included in income from continuing operations. The guidance in this FSP shall be applied to the first reporting period beginning after December 15, 2005, with early adoption permitted. The adoption did not have a significant impact on the Company’s consolidated financial statements.
In February 2006 the FASB issued SFAS No. 155 “Accounting for Certain Hybrid Financial Instruments”. SFAS No. 155 amends SFAS No. 133 to narrow the scope exception for interest-only and principal-only strips on debt instruments to include only such strips representing rights to receive a specified portion of the contractual interest or principal cash flows. SFAS No. 155 also amends SFAS No. 140 to allow qualifying special-purpose entities to hold a passive derivative financial instrument pertaining to beneficial interests that itself is a derivative financial instrument. Generally, SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, requires that a derivative embedded in a host contract that does not meet the definition of a derivative be accounted for separately (referred to as bifurcation) under certain conditions. That general rule notwithstanding, SFAS No. 133 (prior to amendments made to it by SFAS No. 155) provides a broad exception for interest-only and principal-only strips initially resulting from the separation of rights to receive contractual cash flows of a financial instrument that itself does not contain an embedded derivative that would have been accounted for separately. SFAS No. 155 amends SFAS No. 133 to restrict the scope exception to strips that represent rights to receive only a portion of the contractual interest cash flows or of the contractual principal cash flows of a specific debt instrument. Prior to amendments made by SFAS No. 155, SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, permitted a qualifying special-purpose entity (SPE) to hold only passive derivative financial instruments pertaining to beneficial interests (other than another derivative financial instrument) issued or sold to parties other than the transferor. SFAS No. 155 amends SFAS No. 140 to allow a qualifying SPE to hold a derivative instrument pertaining to beneficial interests that itself is a derivative financial instrument. This statement is effective for all financial instruments acquired, or subject to a remeasurement event occurring after the beginning of an entity’s first fiscal year end that begins after September 15, 2006. The Company does not expect adoption of SFAS No. 155 to have a material impact on the Company’s financial statements.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets”, which provides an approach to simplify efforts to obtain hedge-like (offset) accounting. This Statement amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, with respect to the accounting for separately recognized servicing assets and servicing liabilities. The Statement (1) requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in certain situations; (2) requires that a separately recognized servicing asset or servicing liability be initially measured at fair value, if practicable; (3) permits an entity to choose either the amortization method or the fair value method for subsequent measurement for each class of separately recognized servicing assets or servicing liabilities; (4) permits at initial adoption a one-time reclassification of available-for-sale securities to trading securities by an entity with recognized servicing rights, provided the securities reclassified offset the entity’s exposure to changes in the fair value of the servicing assets or liabilities; and (5) requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the balance sheet and additional disclosures for all separately recognized servicing assets and servicing liabilities. SFAS No. 156 is effective for all separately recognized servicing assets and liabilities as of the beginning of an entity’s fiscal year that begins after September 15, 2006, with earlier adoption permitted in certain circumstances. The Statement also describes the manner in which it should be initially applied. The Company does not believe that SFAS No. 156 will have a material impact on its financial position, results of operations or cash flows.
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 clarifies the accounting for income taxes by prescribing a minimum probability threshold that a tax position must meet before a financial statement benefit is recognized. The minimum threshold is defined in FIN 48 as a tax position, that based solely on its technical merits is more likely than not to be sustained upon examination by the applicable taxing authority. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. FIN 48 must be applied to all existing tax positions upon initial adoption. The cumulative effect of applying FIN 48 at adoption, if any, is to be reported as an adjustment to opening retained earnings for the year of adoption. FIN 48 is effective for fiscal years beginning after December 15, 2006, although early adoption is permitted. The Company does not believe that FIN 48 will have a material impact on its financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which provides a single definition of fair value, a framework for measuring fair value, and expanded disclosures concerning fair value. Previously, different definitions of fair value were contained in various accounting pronouncements creating inconsistencies in measurement and disclosures. SFAS No. 157 applies under those previously issued pronouncements that prescribe fair value as the relevant measure of value, except Statement No. 123(R) and related interpretations and pronouncements that require or permit measurement similar to fair value but are not intended to measure fair value. This pronouncement is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS No. 157 to have a material impact on its consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (SFAS No. 158). SFAS No. 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit pension plan and other postretirement plans as an asset or liability on its balance sheet and recognize changes in its funded status in the year in which the change occurs through accumulated other nonnowner changes in equity. We do not expect the adoption of SFAS 158 to have an impact on our results of operations or financial condition.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Assets and Liabilities - Including an Amendment of FASB Statement No. 115. This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in SFAS No. 159 are elective; however, the amendment to SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities. The fair value option established by SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings (or another performance indicator if the business entity does not report earnings) at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company does not expect the adoption of SFAS No. 159 to have a material impact on its consolidated financial statements.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is required to provide quantitative and qualitative information about market risks (interest rate risk, foreign currency risk, commodity price risk and other relevant market risks) to the extent such risks are material to the Company. The Company has no investments in derivative financial instruments or in commodities. We are exposed to interest rate risk with borrowing under our $3 million Working Capital Line and Preferred Stock, both of which bear interest and dividends, respectively, based on the prime rate. As of December 31, 2006, we had $1.4 million outstanding under the Working Capital Line and $7.85 million of Preferred Stock outstanding. An immediate change of one percentage point in the prime rate would have caused an increase or decrease of approximately $100,000 on an annual basis.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company’s consolidated financial statements prepared in accordance with Regulation S-X and Reports of Independent Registered Public Accounting Firms are set forth at the end of this Report on pages 36 through 62.
Item 9.
Item 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
Item 9A.
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, 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, 2006 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.
Material weaknesses in internal control over financial reporting have been identified by the Company’s independent registered public accounting firm during the December 31, 2006 audit process. They identified control deficiencies regarding 1) lack of segregation of duties; 2) lack of timely completion of financial control and reporting processes and 3) lack of formal internal control environment. Management of the Company believes that these material weaknesses are due to the small size of the Company’s accounting staff, exacerbated by the resignation of the Company’s Chief Financial Officer and Corporate Controller prior to the completion of the audit. Management has taken recent actions to replace these positions, however, the small size of the Company’s accounting staff may prevent adequate controls in the future such as segregation of duties due to the cost/benefit of such remediation.
The Company is not an “accelerated filer” (i.e., the Company’s public float is below $75 million) for fiscal year 2006, hence, the internal controls certification and attestation requirements of Section 404 of the Sarbanes-Oxley Act will not be applicable to the Company until the fiscal year ended December 31, 2007. Notwithstanding the fact that these internal control requirements are not applicable to the Company at this time, 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.
Item 9B.
Item 9B. OTHER INFORMATION
None.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 will be set forth in the 2007 Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 2007 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.
Item 11. EXECUTIVE COMPENSATION
The information required by Item 11 will be set forth in the 2007 Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 2007 under the caption “Executive Compensation” and is incorporated herein by this reference.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by Item 12 will be set forth in the 2007 Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 2007 under the captions “Information About JMAR Stock Ownership” and “Equity Compensation Plan Information” and is incorporated herein by this reference.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 will be set forth in the 2007 Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 2007 under the caption “Certain Transactions with Management and Others” and is incorporated herein by this reference.
Item 14.
Item 14. PRINCIPAL AUDITOR FEES AND SERVICES
The information required by Item 14 will be set forth in the 2007 Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 2007 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.
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:
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets as of December 31, 2006 and 2005
Consolidated Statements of Operations for the Years Ended December 31, 2006, 2005 and 2004
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004
Notes to Consolidated Financial Statements
2.
Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts
All other financial statement schedules are not required under the related instructions or are inapplicable and therefore have been omitted.
3.
Exhibits. The Exhibits listed in the accompanying Exhibit Index on pages 64 to 68 are filed as part of this Form 10-K.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
JMAR Technologies, Inc
San Diego, California
We have audited the consolidated balance sheet of JMAR Technologies, Inc. (the “Company”) as of December 31, 2006 and the related consolidated statements of operations, stockholders’ deficit, and cash flows for the year then ended. Our audit also includes the financial statement schedule of JMAR Technologies, Inc. listed in Schedule II. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audit 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of JMAR Technologies, Inc. as of December 31, 2006, and the results of its operations and its cash flows for the year then ended in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring losses from operations and its total liabilities exceed its total assets. This raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Santa Ana, California
March 29, 2007
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
JMAR Technologies, Inc.:
We have audited the accompanying consolidated balance sheet of JMAR Technologies, Inc. (a Delaware corporation) as of December 31, 2005, and the related consolidated statements of operations, stockholders’ equity and cash flows for the two years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements 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, 2005, and the consolidated results of its operations and its consolidated cash flows for each of the two years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
Irvine, California
April 6, 2006 (except for Note 9, as to which the date is March 29, 2007)
JMAR TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
As of December 31, 2006 and 2005
The accompanying notes to these consolidated financial statements are an integral part of these consolidated balance sheets.
JMAR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2006, 2005 and 2004
The accompanying notes to these consolidated financial statements are an integral part of these consolidated statements of operations.
JMAR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2006, 2005 and 2004
The accompanying notes to these consolidated financial statements are an integral part of these consolidated statements of stockholders’ equity.
JMAR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2006, 2005 and 2004
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITY: During the years ended December 31, 2006 and 2005, the Company recorded a discount of $2,210,031 and $1,066,803, respectively, representing the difference between the fair value of the Convertible Preferred Stock and warrants immediately prior to and after the March 28, 2006 and February 1, 2005 amendments, respectively (see Note 11). Also, during the year ended December 31, 2006, the Company recorded a discount of $471,926 representing the fair value of warrants issued in connection with the 2006 Working Capital Line (see Note 8). In addition, during the year ended December 31, 2005, the Company recorded $1,247,897 for the fair value of license rights and certain assets acquired in connection with the license agreement entered into with PointSource Technologies, LLC in January 2005 in exchange for common stock and warrants (see Note 15). Also, during the year ended December 31, 2005, the Company recorded the redemption of the Series E Convertible Preferred Stock with a fair value of consideration issued of $1,337,500 and a carrying value of $957,003 (see Note 11). During the year ended December 31, 2004, the holder of the Convertible Preferred Stock converted $3,500,000 of the preferred stock into 2,003,205 shares of common stock of the Company. The Company recorded a discount of $1,772,225 representing the beneficial conversion feature of the redeemable convertible preferred stock and debt and the fair value of warrants issued in connection with the preferred stock and debt transactions in 2004 (see Notes 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 of cash flows.
JMAR TECNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
1. Description of the Company and Financial Condition
The accompanying consolidated financial statements include the accounts of JMAR Technologies, Inc. (the “Company” or “JMAR”) and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
JMAR is an innovator in the development of laser-based technology and x-ray processes for nano-scale imaging, analysis and fabrication. The Company is leveraging more than a decade of laser and photonics research to develop a portfolio of products with commercial applications in rapidly growing industries, while continuing to carry out research and development for the U.S. Government.
JMAR’s BioSentry product is a contamination warning system for waterborne microorganisms. BioSentry uses laser-based, multi-angle light scattering technology to provide continuous, on-line, real-time monitoring for harmful microorganisms. BioSentry is targeted toward a number of applications across multiple markets, including homeland security, the cruise ship and beverage industries, pharmaceutical companies, and municipal water utilities.
JMAR’s pursuit of leading edge products targets nanotechnology, bioscience and the semiconductor industries with its BriteLight laser, a stand-alone product as well as the x-ray light source in nanolithography systems; the X-ray Microscope for 3D visualization of single cells and polymers; and the X-ray Nano Probe for enabling nano-scale interaction, analysis and materials modification. In addition, JMAR employs a key strategic alliance for the prototyping and production of a nanoparticle ultra-thin coating system.
The accompanying consolidated financial statements have been prepared by the Company on a going concern basis, which contemplates the realization of amounts and satisfaction of obligations in the normal course of business. The Company incurred net losses of $13,106,681 and $8,032,803 for the years ended December 31, 2006 and 2005, respectively, and losses are expected for the foreseeable future. In addition, excluding discontinued operations, our revenues declined to $4,857,092 from $5,764,252 for the years ended December 31, 2006 and 2005, respectively. We had negative operating cash flow for the years ended December 31, 2006 and 2005 of $6,595,411 and $4,806,376, respectively. Our cash requirements have been and will continue to be significant. We will continue to use cash in 2007 for 1) product development efforts; 2) corporate costs, primarily related to the cost of being a public company; 3) preferred stock redemptions and dividends; and 4) other working capital needs. If the Company’s new products do not result in significant commercial sales, we will need to raise additional funds in order to continue our product development and sales and marketing activities and for other working capital needs. Assuming the completion of a proposed $750,000 financing from Laurus Master Fund, management believes that it will have adequate resources to fund its operations through June 30, 2007.
In March 2006, General Dynamics Advanced Information Systems (GDAIS) informed the Company that Defense Microelectronics Activity (DMEA) desired to avoid the additional funding required to support the costs imposed by JMAR working under GDAIS as a subcontractor on the DMEA Contract and that the funding will only be sufficient for the prime contractor. Accordingly, JMAR will not receive additional subcontract funding from GDAIS. The viability of the Microelectronics Division was dependent on continued funding from GDAIS/DMEA. The Company has substantially completed the administrative run-off aspects of the GDAIS contract including billing and collection of receivables, payments to vendors, and government audits. The Company has reflected the Microelectronics Division as a discontinued operation in the accompanying financial statements. See “Discontinued Operations” (Note 9) for additional information.
Management believes that the Company’s losses in recent years have resulted from a combination of insufficient contract revenue generated earnings to support the Company’s new product development and commercialization work, the time necessary for it to begin generating significant revenue from those new products, and the significant administrative cost of being a small public company. There can be no assurance that projected revenue growth will occur or that the Company will successfully implement its plans. Additionally, there can be no assurance that suitable financing will be available on acceptable terms, on a timely basis, or at all.
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.
c. Pervasiveness of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
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.
e. Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, “Accounting for Income Taxes.” 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 FASB Statement No. 142, “Goodwill and Other Intangible Assets,” 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 of the DARPA Contract was included in the Government’s fiscal year 2005 budget. A further evaluation of goodwill was performed again as of December 31, 2004, December 31, 2005, June 30, 2006 and December 31, 2006. Until September 30, 2006, the business units identified were Vermont Operations/Research Division, Microelectronics Division and Sensor Products Group. With the discontinuance of the Microelectronics Division, the Company now has two business units. 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 development and commercialization, with the source and technology development coming from the Research Division and the product design, manufacturing engineering, integration, testing and assembly performed by the Vermont Operations, as well as the zone plate optics development and manufacturing for the future laser based products to be performed by the Vermont Operations). Additionally, the Vermont Operations will use its core capabilities to perform manufacturing for other products of the Company.
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 in the future based on its current knowledge of the market and our expectations of successfully penetrating those markets.
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 two 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).
Based on the Company’s analysis as of December 31, 2006, the entire amount of goodwill of $4,415,932 was written off.
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 $924,366 and $948,354 at December 31, 2006 and 2005, respectively (see Note 15). 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 at December 31, 2006.
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. 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, 2006, 2005 and 2004, in excess of 90% of the Company’s revenues were contract revenues, with the remainder two BriteLight sales, BioSentry revenues, 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.
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 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.
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. Allowances for Doubtful Accounts
JMAR maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of JMAR’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Management reviews delinquent accounts at least quarterly, to identify potential doubtful accounts, and together with customer follow-up estimates the amounts of potential losses.
m. 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, 2006, 2005 and 2004, the denominator in the diluted loss per share computation was the same as the denominator for basic loss per share due to antidilutive effects of the Company’s warrants, stock options, convertible debt and convertible preferred stock. As of December 31, 2006, 2005 and 2004, the Company had shares issuable under outstanding warrants, stock options, convertible debt and convertible preferred stock of 15,880,367, 13,738,888 and 7,982,506, respectively, all of which are antidilutive and were excluded from the computation of diluted loss per share due to the Company’s losses.
n. Stock-Based Compensation Plans
The Company has six stock plans, the 2006 Equity Incentive Plan (2006 Plan), the 1991 Stock Option Plan (1991 Plan), the 1999 Stock Option Plan (1999 Plan), the Management Anti-Dilution Plan (Anti-Dilution Plan) and two incentive plans which provided for the issuance of options to Research Division employees (Research Division Plans). The 2006 Plan and the 1999 Plan are the only shareholder-approved stock option plans from which additional options may be granted. The 2006 Plan authorizes the grant of up to 2,000,000 shares and options and the 1999 Plan authorizes the grant of options to purchase up to 1,900,000 shares of the Company’s common stock. The Company is also a party to non-plan option agreements with several individuals. Prior to January 1, 2006, the Company accounted 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 proforma amounts for the years ended December 31, 2005 and 2004 (unaudited):
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 2005 and 2004: risk-free interest rate of approximately 4.27 percent in 2005 and 4.41 percent in 2004; expected dividend yields of 0 percent and expected lives of 6 years. For grants in 2005 and 2004, the expected volatility used was 102 percent and 255 percent, respectively.
Effective January 1, 2006, the Company adopted SFAS No. 123(R), using the modified prospective transition method (see Note 12).
o. Reclassifications and Revisions
Certain reclassifications have been made to the prior year financial statements to conform with the 2006 presentation.
p. Recent Accounting Pronouncements
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 108 to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires that registrants quantify the impact on the current year’s financial statements of correcting all misstatements, including the carryover and reversing effects of prior years’ misstatements, as well as the effects of errors arising in the current year. SAB 108 is effective as of the first fiscal year ending after November 15, 2006, allowing a one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006, for errors that were not previously deemed material, but are material under the guidance in SAB No. 108. There was no impact on our consolidated financial statements with respect to the adoption of SAB No. 108.
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 SFAS No. 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 the production facilities. The adoption of SFAS No. 151 did not have a significant effect on the Company’s consolidated financial statements.
In May 2005, the FASB issued FASB Statement No. 154, “Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3” (SFAS No. 154). This Statement changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Therefore, we have adopted the provisions of SFAS No. 154 for our fiscal year beginning January 1, 2006 as applicable. The adoption of the provisions of SFAS No. 154 did not have a material impact on our consolidated financial statements.
In October 2005, the FASB issued FSP FAS 13-1, “Accounting for Rental Costs Incurred during a Construction Period”, which addresses the accounting for rental costs associated with operating leases that are incurred during a construction period. This FSP requires that rental costs associated with ground or building operating leases incurred during a construction period be recognized as rental expense and included in income from continuing operations. The guidance in this FSP shall be applied to the first reporting period beginning after December 15, 2005, with early adoption permitted. The adoption did not have a significant impact on the Company’ s consolidated financial statements.
In February 2006 the FASB issued SFAS No. 155 “Accounting for Certain Hybrid Financial Instruments”. SFAS No. 155 amends SFAS No. 133 to narrow the scope exception for interest-only and principal-only strips on debt instruments to include only such strips representing rights to receive a specified portion of the contractual interest or principal cash flows. SFAS No. 155 also amends SFAS No. 140 to allow qualifying special-purpose entities to hold a passive derivative financial instrument pertaining to beneficial interests that itself is a derivative financial instrument. Generally, SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, requires that a derivative embedded in a host contract that does not meet the definition of a derivative be accounted for separately (referred to as bifurcation) under certain conditions. That general rule notwithstanding, SFAS No. 133 (prior to amendments made to it by SFAS No. 155) provides a broad exception for interest-only and principal-only strips initially resulting from the separation of rights to receive contractual cash flows of a financial instrument that itself does not contain an embedded derivative that would have been accounted for separately. SFAS No. 155 amends SFAS No. 133 to restrict the scope exception to strips that represent rights to receive only a portion of the contractual interest cash flows or of the contractual principal cash flows of a specific debt instrument. Prior to amendments made by SFAS No. 155, SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, permitted a qualifying special-purpose entity (SPE) to hold only passive derivative financial instruments pertaining to beneficial interests (other than another derivative financial instrument) issued or sold to parties other than the transferor. SFAS No. 155 amends SFAS No. 140 to allow a qualifying SPE to hold a derivative instrument pertaining to beneficial interests that itself is a derivative financial instrument. This statement is effective for all financial instruments acquired, or subject to a remeasurement event occurring after the beginning of an entity’s first fiscal year end that begins after September 15, 2006. The Company does not expect adoption of SFAS No. 155 to have a material impact on the Company’s financial statements.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets”, which provides an approach to simplify efforts to obtain hedge-like (offset) accounting. This Statement amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, with respect to the accounting for separately recognized servicing assets and servicing liabilities. The Statement (1) requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in certain situations; (2) requires that a separately recognized servicing asset or servicing liability be initially measured at fair value, if practicable; (3) permits an entity to choose either the amortization method or the fair value method for subsequent measurement for each class of separately recognized servicing assets or servicing liabilities; (4) permits at initial adoption a one-time reclassification of available-for-sale securities to trading securities by an entity with recognized servicing rights, provided the securities reclassified offset the entity’s exposure to changes in the fair value of the servicing assets or liabilities; and (5) requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the balance sheet and additional disclosures for all separately recognized servicing assets and servicing liabilities. SFAS No. 156 is effective for all separately recognized servicing assets and liabilities as of the beginning of an entity’s fiscal year that begins after September 15, 2006, with earlier adoption permitted in certain circumstances. The Statement also describes the manner in which it should be initially applied. The Company does not believe that SFAS No. 156 will have a material impact on its financial position, results of operations or cash flows.
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 clarifies the accounting for income taxes by prescribing a minimum probability threshold that a tax position must meet before a financial statement benefit is recognized. The minimum threshold is defined in FIN 48 as a tax position, that based solely on its technical merits is more likely than not to be sustained upon examination by the applicable taxing authority. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. FIN 48 must be applied to all existing tax positions upon initial adoption. The cumulative effect of applying FIN 48 at adoption, if any, is to be reported as an adjustment to opening retained earnings for the year of adoption. FIN 48 is effective for fiscal years beginning after December 15, 2006, although early adoption is permitted. The Company does not believe that FIN 48 will have a material impact on its financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which provides a single definition of fair value, a framework for measuring fair value, and expanded disclosures concerning fair value. Previously, different definitions of fair value were contained in various accounting pronouncements creating inconsistencies in measurement and disclosures. SFAS No. 157 applies under those previously issued pronouncements that prescribe fair value as the relevant measure of value, except Statement No. 123(R) and related interpretations and pronouncements that require or permit measurement similar to fair value but are not intended to measure fair value. This pronouncement is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS No. 157 to have a material impact on its consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans (SFAS No. 158). SFAS No. 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit plan and other postretirement plans as an asset or liability on its balance sheet and recognize changes in its funded status in the year in which the change occurs through accumulated other nonowner changes in equity. We do not expect the adoption of SFAS 158 to have an impact on our results of operations or financial condition.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Assets and Liabilities - Including an Amendment of FASB Statement No. 115. This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in SFAS No. 159 are elective; however, the amendment to SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities. The fair value option established by SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings (or another performance indicator if the business entity does not report earnings) at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company does not expect the adoption of SFAS No. 159 to have a material impact on its consolidated financial statements.
3. Impairment of Long-Lived Assets
In 2006, goodwill in the amount of $4,415,932 was written off. The goodwill relates to the Research Division/Vermont Operations reporting unit. The write-off was based on an analysis performed in February 2007 in accordance with FASB Statement No. 142 (See Note 2). Impacting the analysis was the Company’s low market capitalization due to its reduced stock price. In addition, the discounted cash flow analysis was impacted by the agreement reached with a leading microscopy company whereby the Company sold its XRM technology in exchange for an up front cash payment, future royalties and the exclusive laser supplier rights for the XRM. In addition, based on the status of the Company’s BioSentry partner search initiated in June 2006, for purposes of the goodwill analysis, the assumption was that BioSentry manufacturing will be outsourced at some time in the future. In addition, due to its current financial situation, JMAR’s ability to finance the development, commercialization and sale of its products has been impacted, thereby delaying the development and commercialization of the Company’s products.
4. Accounts Receivable
At December 31, 2006 and 2005, accounts receivable consisted of the following:
All unbilled receivables at December 31, 2006 are expected to be billed and collected within one year. Payments to the Company for performance on certain U.S. Government contracts are subject to progress payment audits by the Defense Contract Audit Agency (DCAA) and are recorded at the amounts expected to be realized. The unbilled receivables at December 31, 2006 relates to the normal billing cycle and timing of billings. In addition, included in the long-term “other assets” on the accompanying Consolidated Balance Sheet is $164,197 of withheld fees from the Company’s DARPA Contract that it expects to receive upon completion of the contract and final DCAA audit. The allowance for doubtful accounts at December 31, 2006 relates to accounts receivable from FemtoTrace, Inc.
5. Inventories
Inventories are carried at the lower of cost (on the first-in, first-out basis) or market and are comprised of materials, direct labor and applicable manufacturing overhead. At December 31, 2006 and 2005, inventories consisted of the following:
6. Property and Equipment
At December 31, 2006 and 2005, property and equipment consisted of the following:
Included in leasehold improvements is $346,000 of gross proceeds for lease incentives the Company received from its landlord. These lease incentives were recorded as deferred rent to be amortized on a straight-line basis to rent expense over the life of the leases. Of the net remaining deferred rent of $288,334, $238,905 is included in “notes payable and other long-term liabilities” and the balance of $49,429 is included in “deferred rent” in current liabilities on the accompanying Consolidated Balance Sheet.
7. Commitments and Contingencies
a. Leases
The Company leases its office facilities under various operating leases expiring through October, 2012. Minimum future rental payments for non-cancelable leases as of December 31, 2006, are as follows:
Related rent expense was $532,186, $622,428 and $525,716 for the years ended December 31, 2006, 2005 and 2004, 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 agreed to 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. Dr. Martinez ceased to be a director effective April 22, 2005. 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 these two employees included in notes payable and other long-term liabilities on the accompanying Balance Sheet at December 31, 2006 is $382,500.
Included in “Selling, general and administrative” in the accompanying Statement of Operations is $138,999, $180,023 and $180,126 in 2006, 2005 and 2004, respectively, for the amortization of the discounts recorded against the deferred compensation obligations. Total deferred compensation obligations for 2007 through 2009 are $275,297, $185,955 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, 2006 and 2005, were as follows:
In March 2003, the Company entered into a Revolving Fixed Price Convertible Note (Working Capital Line) with Laurus Master Fund (Laurus). The term of the Working Capital line expired on March 21, 2006 and was replaced by a new line of credit facility (2006 Working Capital Line) (see below). The Working Capital Line allowed 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 were allowed, however, with the consent of Laurus. Laurus could 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 was in excess of the Conversion Price. The Company could convert a portion of the principal outstanding to common stock at the Conversion Price if the market price of the Company’s common stock averaged 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.
On March 28, 2006, the Company and Laurus replaced the Working Capital Line with the 2006 Working Capital Line. The 2006 Working Capital Line allows the Company to borrow from time-to-time up to 90% of eligible accounts receivable and up to 50% of eligible inventory up to $500,000, up to an aggregate maximum of $3 million. Upon approval of Laurus, the 2006 Working Capital Line provides for advances in excess of the availability (Overadvance). The 2006 Working Capital Line is non-convertible and has no financial ratio covenants. The interest rate (8.25 percent at December 31, 2006) on the 2006 Working Capital Line is equal to the prime rate plus 2 percent. The 2006 Working Capital Line terminates in March 2008. As of December 31, 2006, there was $1,422,428 outstanding under the 2006 Working Capital Line, including a $500,000 Overadvance.
In connection with the 2006 Working Capital Line, the Company issued two warrants to Laurus to purchase approximately 458,181 shares of common stock at an exercise price of $0.01 per share and paid fees of $108,000. Of the 458,181 warrants, up to 240,000 vest in March 2007 based on the average borrowings under the 2006 Working Capital Line. Both warrants expire in March 2016. In connection with the issuance of these warrants, the Company recorded a discount of $471,926, representing the fair value of the 458,181 warrants based on the Black Scholes pricing model using the following assumptions: risk-free interest rate of 4.9 percent based on estimated yields of 10-year U.S. Treasury Securities; expected dividend yield of 0 percent; expected life of 10 years; and expected volatility of 91 percent. The volatility is based on JMAR’s historical stock prices for the past ten years, consistent with the expected life of the warrants.
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, 2006, the unamortized discount and fees of $363,079, was offset against borrowings on the Working Capital Line in the accompanying Consolidated Balance Sheet. At December 31, 2005, the unamortized discount and fees of $38,315 was included in “prepaid expenses and other” in the accompanying Consolidated Balance Sheet. The discount is amortized over the remaining life of the Working Capital Line, resulting in $256,169 and $206,821 of interest expense for the years ending December 31, 2006 and 2005, 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 10.2% and 6.2% for 2006 and 2005, respectively. There was no amount outstanding at any time during 2005. The maximum amount outstanding was $2,998,910 for 2006, and the average amount outstanding was approximately $1,299,687 during 2006. The effective interest rate, including the amortization of the beneficial conversion feature and fair value of warrants was 12.2% in 2006.
Interest paid for the years ended December 31, 2006, 2005 and 2004 was $141,998, $33,596 and $62,139, respectively.
9. Discontinued Operations
A major source of revenue has been 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 former McClellan Air Force Base in Sacramento for the DMEA (GDAIS Contract). This work, which started in 1998, resulted in a new subcontract each year out of funds available in the DMEA’s budget as an element of the Department of Defense’s Advanced Technology Support Program. The Company received $3.5 million in contracts in 2004, $2.3 million in letter contracts in 2005 and the final approximately $1.9 million against a $4.2 million contract finalized in February 2006.
In March 2006, GDAIS informed the Company that DMEA desired to avoid the additional funding required to support the costs imposed by JMAR working under GDAIS as a subcontractor on the DMEA Contract and that the funding will only be sufficient for the prime contractor. Accordingly, JMAR will not receive additional subcontract funding from GDAIS. The viability of the Microelectronics Division was dependent on continued funding from GDAIS/DMEA.
During 2006, the Company completed substantially all of the administrative run-off aspects of the GDAIS Contract including billing and collection of receivables, payments to vendors, and government audits. Accordingly, the Company has reflected the Microelectronics Division as a discontinued operation as of December 31, 2006.
During 2006 the Company recorded an expense of $127,911 for assets to be disposed and $262,246 related to leases of the Microelectronics Division, primarily the facility lease, based on an appropriate discount rate. The lease provided for rent and related expenses of approximately $15,800 per month through May 2008.
In the first quarter of 2002, the Company decided to discontinue its standard semiconductor products business. The standard semiconductor products business has been accounted for in the accompanying consolidated financial statements as discontinued operations.
The gain from operations of discontinued operations for the year ended December 31, 2004 includes a loss of $214,893 related to the former facility of the standard semiconductor products business.
Prior to December 31, 2001, as the level of business expected from the standard semiconductor products business did not materialize, the Company decided to take action to sublease the Irvine facility and move the standard semiconductor products business into a smaller facility and recorded a reserve of $547,000 against the Irvine facility lease based on an appropriate discount rate and estimated sublease rental income. The lease provided 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 continued 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. 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. This lease expired in August, 2005.
At December 31, 2006 and December 31, 2005, net assets and liabilities of the discontinued operations consisted of the following:
The gain (loss) from operations of discontinued operations for the years ended December 31, 2006, 2005 and 2004 consisted of the following:
10. Income Taxes
The tax effects of temporary differences that give rise to significant deferred tax assets and liabilities at December 31, 2006 and 2005 are presented below:
The valuation reserve as of December 31, 2006 and 2005 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 $3,925,000 and $2,320,000 in 2006 and 2005, respectively. The capital loss carryforward relates to the sale of JPSI, can only be applied against capital gains and expires in 2008.
The effective income tax rate for the years ended December 31, 2006, 2005 and 2004 varied from the statutory federal income tax rate as follows:
At December 31, 2006, the Company had Federal net operating loss carryforwards of approximately $62.4 million that expire from 2007 to 2026. In addition to the capital loss carryforward, the Company has approximately $8,098,000 of temporary differences that will offset future taxable income subject to the change in ownership limitations discussed below. Also, the Company has approximately $22.2 million of state net operating loss carryforwards that expire from 2011 to 2016.
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 $658,000 apply to approximately $2,512,000 of Company and acquired company loss carryforwards. Approximately $59.9 million of the net operating loss carryforwards are not subject to annual limitations.
11. Equity Transactions
a. Laurus Preferred Stock and Warrants
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 (2005 Amendment). As discussed below, the Series E was fully redeemed at the end of 2005 and the Series F-H were further amended in 2006. The 2005 Amendments provided for, among other things, 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 plus a 2% fee) for the Series E Preferred Stock were deferred and due in full in 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 plus a 2% fee) were deferred until February, 2007; and 2) 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. Pursuant to the 2005 Amendments, the $150,000 in monthly redemption payments under the Series F-H Preferred Stock was scheduled to recommence in August, 2006 and continue 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.
As a result of the 2005 Amendment, the Company recorded an additional discount of approximately $1.1 million, representing the difference between the fair value of the Preferred Stock immediately prior to and after the 2005 Amendment, valued based on the Black Scholes pricing model using the following assumptions: risk-free interest rate of 3.23 percent based on estimated yields of 2-year U.S. Treasury Securities; expected dividend yield of 0 percent; remaining contractual life of 2 years; and expected volatility of 108 percent. The volatility is based on JMAR’s historical stock prices for the past two years, consistent with the remaining contractual life of the preferred stock. This amount was recorded during the first quarter of fiscal year 2005 as a reduction of preferred stock and is amortized to preferred stock dividends over the earlier of the redemption payment period or the conversion dates.
On December 22, 2005, the Company entered into a Securities Purchase Agreement with Laurus whereby in exchange for and in complete cancellation (Redemption) of all of the remaining $1,000,000 of Series E Preferred Stock, the Company issued 1,041,667 shares of the Company’s common stock, valued at a discount to the closing stock price of the Company on December 19, 2005. In addition, the Company issued a warrant for the purchase of 375,000 shares of common stock, with an exercise price of $1.50, based on 125% of the closing price of the Company’s common stock on December 19, 2005. The warrant is not exercisable for the first six months and has a term of five years. Prior to the Redemption, the Series E Preferred Stock was redeemable in full in the amount of $1,000,000 in July 2006, if not previously converted to common stock.
As a result of the Redemption in the quarter ended December 31, 2005, the Company recorded the excess of the fair value of the consideration issued to Laurus ($1,337,500) over the carrying amount of the Series E Preferred Stock ($957,003) as preferred stock dividends and an increase in paid-in-capital. The stock issued to Laurus was valued based on a 10 percent discount to market price of JMAR’s stock and the warrants were valued based on the Black Scholes model using the following assumptions: risk-free interest rate of 4.18 percent based on estimated yields of 5-year U.S. Treasury Securities; expected dividend yield of 0 percent; expected life of 5 years; and expected volatility of 63 percent. The volatility is based on JMAR’s historical stock prices for the past five years, consistent with the expected life of the warrants.
On March 28, 2006, the Company issued a new Series I Convertible Preferred Stock to replace $6,393,980 of the Series F-H Convertible Preferred Stock, leaving $1,456,020 of the Series G Preferred Stock outstanding. The parties also amended the remaining redemption schedule of the Series G Preferred Stock (the issuance of the Series I and the amendments to the Series G are referred to below as the 2006 Amendments). The 2006 Amendments have the effect of deferring the $7,850,000 in redemption payments, as follows: a) 6 monthly redemption payments originally commencing August 2006 ($150,000 per month plus a 2% fee) are deferred one year and reduced to $122,178 per month; b) $6,588,314 of the redemption payment originally due February 2007 is deferred until August 2008; and c) the remaining $528,618 is payable at $27,822 per month starting February 2007 through August 2008. The conversion price for the $6,393,980 of the Series F-H Preferred Stock was originally $2.00 while the new $6,393,980 of Series I Preferred Stock has a conversion price of $1.16 per share. In addition, the exercise price (originally ranging from $3.42 to $3.82) of the warrants exercisable into 200,000 shares originally issued in connection with the Series F-H Preferred Stock was reduced to $1.16. The redemption payments will be reduced to the extent that there are conversions of the Preferred Stock into common stock. The rights and privileges of the Series I Preferred Stock are the same as the Series F-H Preferred Stock, other than the conversion price and redemption payments.
As a result of the 2006 Amendments, the Company recorded an additional discount of approximately $2.2 million, representing the difference between the fair value of the Preferred Stock and warrants immediately prior to and after the 2006 Amendments, valued based on the Black Scholes pricing model using the following assumptions: risk-free interest rate of 4.7 percent for the value prior to the 2006 Amendments, 4.8 percent for the value after the 2006 Amendments and 4.8 percent for the value of the warrants based on estimated yields of 1-year, 2-year and 5-year Treasury Securities, respectively; expected dividend yield of 0 percent; remaining contractual life of 10 months for the value prior to the 2006 Amendments, 28 months for the value after the 2006 Amendments and 59 months for the value of the warrants; and expected volatility of 51 percent for the value before the 2006 Amendments, 76 percent for the value after the 2006 Amendments and 81 percent for the value of the warrants. The volatility is based on JMAR’s historical stock prices for the past 10 months, 28 months and 59 months, respectively, consistent with the remaining contractual life of the preferred stock before and after the 2006 Amendments and warrants, respectively.
If not previously converted, the Series G and I Preferred Stock, as amended, must be redeemed by the Company as follows:
In connection with all of the above financing transactions with Laurus, the Company issued warrants to Laurus to purchase a total of 1,786,375 shares of common stock at prices ranging from $1.058 to $5.15. In addition, in connection with the 2006 Working Capital Line on March 28, 2006, Laurus was granted two warrants exercisable into up to 458,181 shares of common stock at an exercise price of $0.01 per share. As of March 26, 2007 all of the preferred stock and warrants held by Laurus is convertible or exercisable into approximately 9.1 million shares.
The following table summarizes the preferred stock activity for 2006:
The following table summarizes the preferred stock activity for 2005:
All of the preferred stock and warrants (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 9.99% 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 shares of the Company’s common stock (as of various issuance dates of the securities) unless and until the Company obtains stockholder approval of such excess. Excluded from such calculation are all shares issued to Laurus upon conversion of convertible preferred stock or exercise of warrants but no longer owned by Laurus.
Included in the loss applicable to common stock in the accompanying Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004 are preferred stock dividends of $1,283,668, $2,091,232 and $2,247,876, respectively. The amount for the years ended December 31, 2006, 2005 and 2004 represents $633,451, $571,529 and $341,372, respectively, of preferred stock dividends paid or payable in cash and $650,217, $1,139,206 and $1,906,504, respectively, related to the discount representing the beneficial conversion feature of the redeemable convertible preferred stock, the fair value of warrants issued in connection with the preferred stock, and the difference between the fair value of the preferred stock immediately prior to and after the 2005 and 2006 Amendments. In addition, the 2005 amount includes $380,497 related to the excess of the fair value of the consideration issued by the Company for the redemption of the Series E Preferred Stock over its carrying amount.
b. Sales of Common Stock and Warrants
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 (February Investors). Pursuant to the Securities Purchase Agreement, the Company issued a total of 3,255,807 shares of common stock and warrants to purchase 1,209,679 shares of common stock to the February Investors. The warrants have an exercise price of $1.73 per share and a term of five years. After expenses of the transaction and the advisor’s fee, the Company received net proceeds of approximately $3,852,000.
As a result of the completion of the February 2005 Offering, certain investors were offered the right to purchase a total of 53,548 shares of common stock (Additional Shares) and warrants to purchase 20,081 shares of common stock with an exercise price of $1.73 per share (Additional Warrants) for a total purchase price of $66,400. In mid-February, 2005, these investors purchased the Additional Shares and Additional Warrants for $66,400.
On December 28, 2005 and January 4, 2006, the Company entered into Securities Purchase Agreements and completed the sale of $3.63 million of the Company’s common stock and warrants to nine institutional investors and four accredited individual investors (December Investors). Pursuant to the Securities Purchase Agreements, the Company issued a total of 3,025,001 shares of common stock and warrants to purchase 2,117,501 shares of common stock to the December Investors. The warrants have an exercise price of $1.44 per share and a term of five and one-half years. After expenses of the transaction and advisor’s fee, the Company received net proceeds of approximately $3.4 million, of which approximately $1.4 million was received after December 31, 2005 and, accordingly, is not included in the Company’s cash and cash equivalents of $5,279,691 at December 31, 2005.
c. Issuance of Warrants
A summary of the status of the total number of warrants as of December 31, 2006, 2005 and 2004 and changes during the years then ended is presented in the tables below:
A summary of outstanding warrants as of December 31, 2006, 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:
d. Issuances of Common Stock and Warrants for Services
During the years ended December 31, 2006 and 2005, the Company issued 228,418 and 40,538 shares of common stock, respectively, for services. Included in the amount for the year ended December 31, 2006 was 57,000 shares issued to employees. The shares vest after one year, if the employee is still employed by the Company at that time. These issuances were valued based upon the fair market value of the Company’s common stock at the date of issue. In addition, in July 2006, the Company issued a warrant for services to Dian Griesel, President of The Investor Relations Group, exercisable into 50,000 shares of common stock at an exercise price of $0.67 per share. The warrants were valued using the Black Scholes valuation model.
12. Stock-Based Compensation Plans
The Company has six stock-based plans, the 2006 Equity Incentive Plan (2006 Plan), the 1991 Stock Option Plan (1991 Plan), the 1999 Stock Option Plan (1999 Plan), the Management Anti-Dilution Plan (Anti-Dilution Plan), and two incentive plans which provided for the issuance of options to Research Division employees (Research Division Plans). The Company is also a party to a non-plan option agreement with an individual. The 2006 Plan and the 1999 Plan are the only shareholder-approved stock plans from which additional options may be granted.
The Company was authorized to grant options to its employees (including directors) and consultants for up to 2,000,000 shares and options under the 2006 Plan, 1,480,000 shares under the 1991 Plan, 1,900,000 shares under the 1999 Plan, 806,637 shares under the Anti-Dilution Plan and 350,000 shares under the Research Division Plans (Plans). As of December 31, 2006, the Company has issued 185,927 shares under the 2006 Plan, 1,084,691 options under the 1991 Plan, 1,335,252 options under the 1999 Plan, 306,920 options under the Anti-Dilution Plan and 42,500 options under the Research Division Plans. In addition, 50,000 non-qualified options have been granted to one employee 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 2005 and 2004, 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 typically have a term of ten years and vest one-third per year after date of grant. As of December 31, 2006, options to purchase 564,748 shares are available for grant pursuant to the 1999 Plan and shares or options to purchase 1,814,073 are available for grant pursuant to the 2006 Plan.
A summary of option activity under all of the above plans as of December 31, 2006, and changes during the year then ended is presented in the table below:
A summary of option activity under all of the above plans for 2005 and 2004, and changes during the year then ended is present in the table below:
A summary of the options outstanding as of December 31, 2006, 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:
A summary of the status of the Company’s non vested options at December 31, 2006, and changes during the year ended December 31, 2006, is presented below:
The weighted-average grant-date fair value of options granted during the years ended December 31, 2006 and 2005 was $211,021 and $558,454, respectively.
Included in the accompanying Consolidated Statement of Operations for 2006 is compensation expense of $354,981. Of this amount $292,746 is reflected in “selling, general and administrative” and $62,235 is included in “research and development”. The fair value of each option grant is estimated on the date of grant using the Black Scholes option pricing model with the following weighted-average assumptions used for grants in 2006: risk-free interest rate of approximately 4.7 percent based on U.S. Treasury yields in effect at the time of grant; expected dividend yield of 0 percent as the Company has not, and does not intend to, issue dividends; expected lives of 3 to 71 /2 years; and expected volatility of 89 to 100 percent, based on the Company’s historical stock price fluctions for a period matching the expected life of the options.
The total intrinsic value of options exercised during the year ended December 31, 2006 was $5,749. There was no cash received from options exercised for the year ended December 31, 2006 as options exercised were done on a “cashless” basis as the Company received shares of Company stock as payment of the exercise price. There were 33,856 options exercised in the year ended December 31, 2005. The stock based compensation unrecognized expense for future periods as of December 31, 2006 is approximately $384,431 with a weighted average remaining vesting period of 1.1 years.
13. Segment Information
Until the quarter ended September 30, 2006, JMAR conducted its operations in the following three business segments: Research Division/Vermont Operations, Microelectronics Division and Sensor Products Group. As of September 30, 2006, the Microelectronics Division is reflected as discontinued operations and, accordingly, is no longer reflected as a segment. The table below shows the Research Division and Vermont Operations separately in order to provide additional disclosure the Company feels is relevant.
Research Division/Vermont Operations
Research Division - Located in San Diego, California, the Research Division 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. The Research Division’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, the Research Division is developing several soft X-ray enabled products including a family of instruments for nanotechnology applications. JMAR believes that this instrument family will provide the ability to carry out imaging and chemical analysis at resolutions down to 20 nanometers.
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 - Located in South Burlington, Vermont, the Vermont Operations 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. The Vermont Operations also performs funded contract research and development for DARPA and NAVAIR. During 2006, the Research Division/Vermont Operations segment accounted for approximately 98% 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 harmful microorganisms in water. BioSentry is targeted toward a number of applications across multiple markets, including homeland security, the cruise ship and beverage industries, pharmaceutical companies, and municipal water utilities. During 2006, this segment accounted for 2% of the Company’s revenues.
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 based on a three factor formula (revenues, payroll and certain assets).
Segment information for the years ended December 31, 2006, 2005 and 2004 (excluding discontinued operations) is as follows:
The asset writedowns for 2006 of $87,845 are for patent costs related to patents abandoned. The asset writedowns for 2005 of $161,174 include $88,239 for patent costs related to patents abandoned and $72,935 for license costs, related to the termination of a license and a write-down to realizable value of costs associated with another license for a product the Company has decided not to pursue further. The asset writedowns for 2004 of $191,575 are for patent costs related to patents abandoned.
Significant Customers
Sales to the United States Government aggregated $4,370,144, $4,100,616 and $5,404,243 in 2006, 2005 and 2004, respectively. Accounts receivable from the United States Government at December 31, 2006 and 2005 was $1,094,185 and $336,719, respectively.
Export Sales
For the year ended December 31, 2006, all of the Company’s revenues were generated from the United States. For the year ended December 31, 2005, 97.5% of the Company’s revenues were generated from the United States and 2.5% was generated from South Korea. For the year ended December 31, 2004, all revenues were generated from the United States. All assets of the Company are located in the United States.
14. Quarterly Financial Information (Unaudited)
The following is a summary of unaudited quarterly results for the years ended December 31, 2006 and 2005:
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 entire amount of goodwill of $4,415,932 was written off in 2006 (see Note 2). As of December 31, 2006 and 2005, the Company had the following amounts related to other intangible assets:
During 2006, the Company capitalized $150,462 related to patent costs. The Research Division/Vermont Operations accounted for $117,605 of the patent costs and the Sensor Products Group accounted for $32,857.
In January 2005, the Company and PointSource Technologies, LLC (PointSource) entered into a License Agreement granting JMAR an exclusive license covering all PointSource patents and other intellectual property related to the manufacture and sale of scattered-radiation based products used to detect or classify microorganisms in water and other media. As consideration for the License Agreement, the Company issued 520,000 shares of common stock and warrants to purchase 333,333 shares of common stock with an exercise price of $1.38 per share, and a term of 5 years. The stock and warrants were valued at $1,247,897. The stock issued to PointSource was valued based on the market price of JMAR’s stock at the time the agreement was consummated and the warrants were valued based on the Black Scholes model using the following assumptions: risk-free interest rate of 3.63 percent based on estimated yields of 5-year U.S. Treasury Securities; expected dividend yield of 0 percent; expected life of 5 years; and expected volatility of 87 percent. The volatility is based on JMAR’s historical stock prices for the past five years, consistent with the expected life of the warrants. Amortization of the asset began upon first product shipment revenues and is based on the units-of-production method over the expected life of the technology, not to exceed the life of the license.
Absent an increase in the revenues from the BioSentry business area, or completion of strategic or financial partnering to support the continued commercialization of the BioSentry products in the next several months, the Company will need to curtail its financial commitment to this business area until such time as one or more of these events has occurred. If the Company is required to curtail these operations, this would have a material adverse impact on the Company, including the lay-off of key personnel in this business area and the write-off of certain BioSentry related assets.
Aggregate amortization expense of the intangible assets with determinable lives was $11,818, $28,481 and $163,008 for the years ended December 31, 2006, 2005 and 2004, respectively. The unamortized balance of intangible assets is estimated to be amortized as follows:
16. Concentration of Customers Risk
The Company’s top customer (U.S. Government) accounted for approximately 90%, 71% and 85% of revenues for the years ended December 31, 2006, 2005 and 2004, respectively, and accounted for $1,094,185 and $336,719 of accounts receivable as of December 31, 2006 and 2005, respectively.
17. Research and Development Costs
The Company’s research and development (R&D) consists of two types: customer-funded R&D (U.S. government and other companies) and Company-funded R&D. Both types of R&D costs are expensed when incurred.
Total R&D expenditures for 2006, 2005 and 2004 were $6,275,741, $5,926,451 and $5,636,643, respectively. Total R&D expenditures as a percentage of revenues were 129.2%, 102.8% and 88.6% for the years ended December 31, 2006, 2005 and 2004, respectively.
18. Subsequent Events
In the first quarter of 2007, JMAR entered into Securities Purchase Agreements and completed the sale of $366,682 of the Company’s common stock to Laurus. Pursuant to the Securities Purchase Agreements, the Company issued a total of 2,254,467 shares of common stock.
On March 16, 2007, JMAR and a leading microscopy company (Acquirer) entered into an Asset Purchase Agreement (“Agreement”) which provides for the sale of the assets related to JMAR’s x-ray microscopy business, which includes a prototype x-ray microscopy system and related intellectual property (the “XRM Assets”). The consideration for the sale of the XRM Assets consists of: 1) an initial payment of $100,000 and the reimbursement of certain costs associated with the delivery, installation and operational testing of the assets, 2) an additional payment of $500,000 following the installation and successful operation of the current prototype XRM system at the Acquirer’s facility, 3) an additional $100,000 payment upon the achievement by the prototype system of certain stated performance criteria, and 4) a royalty payment equal to five percent (5%) of the revenue received by the Acquirer (or any assignee of the Acquirer) from sales of complete x-ray microscopes, soft x-ray sources based on laser plasma x-ray sources, and x-ray microscopes sold without the source. The royalty will run for a four year period following the Acquirer’s first sale to a third party of an x-ray microscope derived from the XRM assets. Royalties will be paid annually and will not cover any products currently sold by the Acquirer. The Acquirer is not assuming any liabilities other than the ongoing costs of prosecuting and maintaining the patents included in the assets. The Acquirer also agreed to appoint JMAR as the exclusive laser supplier to the Acquirer for its soft x-ray microscopy product line during the extent of the four year royalty period, at an agreed upon discount to list price and subject to the satisfaction of certain technical and delivery requirements by JMAR. The parties also agreed that the Acquirer will place an order for the first production unit of the XRM system from JMAR in 2007 at a discounted priced of approximately $318,000 for the current design.
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.
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.
Index to Exhibits
(+) These contracts are management compensation contracts required to be separately identified pursuant to Item 15 (a) of Form 10-K.
Schedule II
JMAR TECHNOLOGIES, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004