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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended

January 31, 2003

OR

For the transition period from                      to                     

Commission file number 0-5449

COMARCO, INC.

(Exact name of registrant as specified in its charter)

2 Cromwell, Irvine, California 92618

(Address of Principal Executive Offices) (Zip Code)

Registrant’s Telephone Number, Including Area Code: (949) 599-7400

Securities registered pursuant to Section 12(b) of the Act: None

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

Common Stock

(Title of Class)

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

Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by a check mark whether the registrant is an accelerated filers (as defined in Rule 12b-2 of the Act) Yes  ¨  No  x

Common stock outstanding at April 22, 2003 — 7,027,565 shares.

The total number of shares held by non-affiliates on the last business day of the most recently completed second fiscal quarter (July 31, 2002) was 6,794,858. This number was multiplied by $6.60 per share (the closing sale price of the Common Stock on July 31, 2002 in the NASDAQ National Market System, as reported by NASDAQ) to determine the aggregate market value of non-affiliate shares set forth above. (The assumption is made, solely for purposes of the above computation, that all Officers and Directors of registrant are affiliates.)

DOCUMENTS INCORPORATED BY REFERENCE

The Company intends to file with the Securities and Exchange Commission by May 28, 2003 a definitive Proxy Statement (the “2003 Proxy Statement”) relating to its 2003 Annual Meeting of Stockholders, which meeting involves the election of directors and certain other matters. The 2003 Proxy Statement is incorporated by reference in Part III of this Form 10-K and shall be deemed to be a part hereof.

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COMARCO, INC.

FORM 10-K

FOR THE FISCAL YEAR ENDED JANUARY 31, 2003

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PART I

FORWARD-LOOKING STATEMENTS

All statements included or incorporated by reference in this report, other than statements or characterizations of historical fact, are forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements concerning projected revenue, expenses, gross profit and income, manufacturing capacity, our accounting estimates, assumptions and judgments, the market acceptance and performance of our products, the status of evolving technologies and their growth potential, the cost and success of our development projects, the timing of new product introductions, our production capacity, the need for additional capital and the success of pending litigation. These forward-looking statements are based on our current expectations and estimates, management’s beliefs, and certain assumptions made by us. Forward-looking statements can often be identified by words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,” “could,” “potential,” “continue,” similar expressions, and variations or negatives of these words. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. These forward-looking statements speak only as of the date of this report and are based upon the information available to us at this time. Such information is subject to change, and we will not necessarily inform you of such changes. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are listed under the section entitled “Risk Factors” in Part I, Item 1 of this report, and other risks identified from time to time in our filings with the Securities and Exchange Commission (“SEC”), press releases, and other communications.

We file annual, quarterly, and special reports, proxy statements, and other information with the SEC. Our SEC filings are available free of charge to the public over the Internet at the SEC’s website at http://www.sec.gov. Our SEC filings are also available on our website at http://www.comarco.com as soon as reasonably practical following the time that they are filed with or furnished to the SEC. Any document we file with the SEC can be read at the SEC’s public reference rooms in Washington, DC, New York, NY, and Chicago, IL. For further information on the public reference rooms, call the SEC at (800) SEC-0330.

ITEM 1.    BUSINESS

Overview

Comarco, Inc., through its subsidiary Comarco Wireless Technologies, Inc. (collectively, “we,” “Comarco,” or the “Company”), is a leading provider of wireless test solutions for the wireless industry. Comarco also designs and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices. During October 1999, we embarked on a plan to divest our non-wireless businesses, which included the defense and commercial staffing businesses. The divestiture plan was completed during November 2000. Accordingly, our continuing operations consist solely of the operations of Comarco Wireless Technologies, Inc. (“CWT”).

We have two primary businesses: wireless test solutions and wireless applications. Our wireless test solutions business designs and manufactures hardware and software tools for use by wireless carriers, equipment vendors, and others. Our wireless applications business designs and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices.

References to “Fiscal” years in this report refer to our fiscal years ended January 31; for example, “fiscal 2003” refers to our fiscal year ended January 31, 2003.

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Wireless Industry

Beginning in fiscal 2002 and after several years of robust growth, the wireless industry deteriorated, reflecting slowing subscriber growth, intensifying price competition, reduced access to capital and the need to manage cash flow. This trend continued through fiscal 2003 and there are few indications that this trend will not continue into fiscal 2004. Wireless carriers have responded to these challenges by reducing capital spending and focusing on projects that can most directly contribute to their revenue. Wireless carriers are now focused on satisfying customer demand for enhanced data services, seamless and comprehensive coverage, improved quality of service, and faster data transmission. Many of these initiatives require capital spending for additional network capacity and next-generation technologies, also referred to as 2.5G and 3G technologies. With reduced availability of capital and the transition to next-generation technologies, plans, projects, and capital spending are subject to frequent change as wireless carriers reevaluate and reorder their priorities. As a result, demand for our 2G wireless test solutions products has significantly decreased and the spending patterns of the wireless carriers continue to be volatile and difficult to predict.

We anticipate that over the longer-term capital spending growth will be driven by a number of factors, including a growing number of subscribers, increasing minutes of use, and the growing demand for the enhanced data services and improved quality promised by next-generation wireless technologies. The deployment of 2.5G and 3G technologies will require the timely development and manufacture of new or advanced infrastructure equipment, including mobile test and measurement tools specifically designed to address the needs of wireless carriers as they transition their existing 2G networks to next-generation technologies. With a product portfolio of test and measurement tools that currently supports 2.5G and 3G technologies, as well as legacy 2G technologies, and core competencies that include expertise in all current and emerging wireless technology standards, industrial hardware design, software development, and low cost manufacturing, we believe we are well positioned to capitalize on the capital spending cycle for next-generation technologies.

Wireless Technology Transition

Wireless networks have evolved from first generation analog technology, or 1G, to second-generation digital voice technology, or 2G. These digital systems provide improved network capacity and signal quality and are currently the dominant technology for most wireless networks. While the build-out of 2G networks continues, there is an increasing demand for next-generation technologies that provide additional data capacity and transmission speeds that permit wireless transmission of integrated voice, data, and Internet and video traffic. To meet this demand, many wireless carriers are either in the process of upgrading their existing 2G networks to 2.5G and 3G technologies or evaluating options to evolve their networks to these next-generation technologies.

Considered an interim step, 2.5G technologies enable wireless carriers to upgrade their existing 2G networks with software and hardware enhancements. These upgrades often require significant investment in software and equipment, but generally do not require the comprehensive new infrastructure equipment investment required for 3G networks. In addition, while these upgraded networks provide improvements in capacity, coverage and performance, they have significantly less bandwidth capacity and transmission speeds than 3G networks are expected to provide.

In order to address these future network requirements, many carriers are expected to ultimately spend a considerable amount of capital upgrading their wireless networks to 3G technologies. Once upgraded, wireless networks are expected to provide high capacity broadband wireless data services at speeds of up to two megabits per second, with the capacity and speed to support voice, data, mobile Internet access and full-motion video. The use of mobile wireless devices for Internet access and other data transmissions is expected to increase substantially over the next several years.

During the last two years, some major carriers in Europe and Asia began a limited initial build out of the first 3G networks. Regulatory agencies in most European counties, Japan and Korea have already licensed 3G frequencies. In the United States, the FCC is expected to award licenses for 3G frequencies in the next several years. As a result, predominately all of the current demand for 3G infrastructure equipment is driven by the rollout of 3G networks in Europe and Asia.

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Our Business Operations

Wireless Test Solutions

Our wireless test solutions business designs and manufactures hardware and software tools used by wireless carriers, equipment vendors, and others. Radio frequency engineers, professional technicians, and others use these tools to design, deploy, and optimize wireless networks, and to verify the performance and quality of service delivered by the wireless networks once deployed. As wireless carriers deploy 2.5G and 3G technologies across their existing networks, the demand for next-generation wireless test solution products is expected to increase.

Products

Our product offering is based on Seven.Five, our newly developed product platform. Seven.Five is a true breakthrough in testing capability, performance, and versatility. Its infinite flexibility, scalability, and modularity enables our customers to work with all 2G, 2.5G, and 3G technologies, and virtually any combination of test mobiles and multi-band, multi-technology scanning receivers. Whether the test application involves optimization or benchmarking of wireless networks, in-building or in-vehicle testing, fixed or mobile, voice or data, Seven.Five provides the necessary functionality and technology.

Services

Through June 2002, the wireless test solutions business was a provider of engineering services that assisted wireless carriers, equipment vendors, and others deploy, optimize, and evaluate the performance of wireless networks. When engaged, we were able to provide and support skilled RF engineers and professional technicians and the tools best suited for the engagement.

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We began offering engineering services, which were complementary to our wireless test solutions products, to wireless carriers and equipment vendors during the fourth quarter of fiscal 2000. During the subsequent two years, we were awarded several profitable multi-million dollar contracts, as well as numerous smaller engagements. However, as wireless carriers continue to reduce their spending, the competition to provide engineering services had become more intense. Reduced contract pricing and fewer opportunities have resulted in reduced revenue and profitability for all engineering services providers. Accordingly, we decided to exit the engineering services business and eliminate all related costs. During the second quarter of fiscal 2003, we completed our remaining contractual obligations, reduced head count, and sold a portion of the assets used in providing these services.

Wireless Applications

Our wireless applications business designs and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices. Our call box products provide emergency communication over existing wireless networks. In addition to the call box products, we provide system installation and long-term maintenance services. Currently, we have approximately 14,000 call boxes installed, the majority of which are serviced and maintained under long-term agreements.

ChargeSource Products

The wireless applications business also includes the ChargeSource family of mobile power products. Our current offering of ChargeSource products consist of a 70-watt universal AC power adapter, our second-generation mobile power system. By simply changing the compact SmartTips connected to the end of the charging cable, the universal AC power adapter is capable of charging and powering multiple target devices, including most notebook computers, cellular telephones, PDAs, and other handheld devices. During the third quarter of fiscal 2002, the ChargeSource product offering was expanded with the introduction of the 70-watt universal DC power adapter. This universal DC power adapter allows traveling professionals to use all their existing ChargeSource SmartTips on the road or in the air. This device connects to the in-seat power outlet available on most major airlines or the cigarette lighter plug found in automobiles. Targus Group International (“Targus”) currently distributes both of these products.

Until recently, most current notebook computers required no more than 70 watts of power to operate. However, the personal computer industry is currently transitioning to offer notebook computers with increasing power requirements. As the power requirements increase, so does the size of the original equipment of the manufacturer (“OEM”) AC charger sold with the notebook computer. To address this industry wide trend, we have developed a family of ChargeSource products that are compatible with all legacy, current and future laptops. These new ChargeSource products are able to deliver up to 120 watts of power in a very small form factor. The new ChargeSource family of products, which are expected to begin shipping during the second quarter of fiscal 2004, consist of the following:

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Our new ChargeSource products are compatible with existing Smart Tips and are backwards compatible with the 70-Watt adapters, which are expected to be phased out of production during the first half of fiscal 2004.

Marketing, Sales, and Distribution

Wireless Test Solutions.    We market and sell our wireless test solutions products through a direct sales force of technically trained personnel and through independent sales representatives and resellers. Our North American sales are made though our direct sales organization located in California. Sales in Latin and South America and Asia are generally made through our offices located in Singapore and Mexico. These international offices coordinate the marketing, sales, and support efforts of a network of representatives and distributors typically located in the respective geographic regions. During fiscal 2002, we purchased an equity stake in Switzerland based SwissQual AG (“SwissQual”), a developer of speech quality systems and software for measuring, monitoring, and optimizing the quality of mobile, fixed, and IP-based voice and data communications. Under this alliance, SwissQual is responsible for reselling and supporting our co-branded wireless test solution products in Europe and Africa.

Wireless Applications.    Our current ChargeSource mobile power products, which include the 70-watt universal AC power adapter and the universal DC power adapter, are marketed and distributed exclusively by Targus. We market and sell our call box systems through a direct sales force located in California.

Competition

Wireless Test Solutions.    The market for our hardware and software tools for the wireless industry is highly competitive and is served by numerous providers. Our primary competitors with respect to our wireless test solutions products are Agilent Technologies, Ascom, Ericsson, and Allen Telecom. Many of our competitors are larger and have greater financial resources.

The wireless industry is characterized by rapid technological changes, frequent new product and service introductions, and evolving industry standards. To compete successfully in our market, we believe we must have the ability to:

Wireless Applications.    The market for our emergency call box systems is served by numerous providers, including Gaitronics, Talk-A-Phone, and other manufactures of wireless and wireline emergency and information telephones. Numerous providers, including Mobility Electronics, Belkin and Fellowes, as well as the cellular telephone and personal computer OEMs, also serve the market for our ChargeSource mobile power products. Many of our competitors are larger and have greater financial resources. We believe that the patents that cover our wireless applications products provide us with a competitive advantage. However, our ability to compete in these markets depends on our ability to successfully commercialize new technologies in a timely manner, and manufacture and deliver our products in sufficient volumes.

Key Customers

We sell our products to wireless carriers, equipment vendors, and others located throughout the world. A limited number of customers have provided a substantial portion of our revenue. In fiscal 2003, Targus, the exclusive distributor of our mobile power products, provided 41 percent of our revenue. In fiscal 2002, Targus provided 22 percent of our revenue and Nortel Networks provided 12 percent of our revenue under an engineering services contract. In fiscal 2001, Verizon Wireless and AT&T Wireless Services, respectively, provided 13 percent

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and 15 percent of our revenue. Both companies are wireless carriers and customers of our wireless test solutions business. The spending patterns of these customers can vary significantly during the year. Any elimination or change in the spending patterns of these customers could negatively affect our operating results.

Research and Development

We sell our products in markets that are characterized by rapid technology changes, frequent new product and service introductions, and evolving technology standards. Accordingly, we devote significant resources to design and develop new and enhanced products that can be manufactured cost effectively and sold at competitive prices. To focus these efforts, we strive to maintain close relationships with our customers and develop products that meet their needs.

As of April 22, 2003, we employed approximately 40 engineers and other technical personnel who are dedicated to our research and development efforts. Generally, our research and development and other engineering efforts are managed and focused on a product-by-product basis, and can generally be characterized as follows:

If we don’t respond to the needs of our customers with the development of new or enhanced products in a timely manner, our portfolio of products is likely to become technologically obsolete over time. We are currently developing a new wireless test solutions product platform, Seven.Five, in response to the needs of wireless carriers for flexible, scalable, and high-value mobile test and measurement tools. For additional information concerning research and development expenditures, see “Research and Development and Software Development Costs” in Note 2 of notes to consolidated financial statements in Part II, Item 8 of this report.

Manufacturing and Suppliers

We maintain one manufacturing facility located in Irvine, California, which is ISO-9002:1994 certified. Our manufacturing process involves the assembly of numerous individual component products by production technicians. The parts and materials used by us consist primarily of printed circuit boards, specialized subassemblies, fabricated housings and chassis, cellular telephones, and small electric circuit components, such as integrated circuits, semiconductors, resistors, and capacitors. Most of our components and sub-assemblies are made by third parties to our specifications and are generally delivered to us for final assembly and testing.

Patents and Intellectual Property

We hold patents that cover key technical aspects of the products in our wireless applications business. However, we generally rely on a combination of trade secrets, copyrights, and contractual rights to protect the intellectual property embodied in the hardware and software products of our wireless test solutions business.

Industry Practices Impacting Working Capital

Existing industry practices that affect working capital and operating cash flow include the level of variability of customer orders relative to the volume of production, vendor lead times, materials availability for critical parts, inventory levels held to achieve rapid customer fulfillment, and provisions of extended payment terms to certain foreign customers.

Currently, we sell our products under purchase orders that are placed with short-term delivery requirements. As a result, we maintain significant levels of inventory and associated production and technical staff in order to meet

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our obligations. Delays in planned customer orders could result in higher inventory levels and negatively impact our operating results.

Our standard terms require customers to pay for our products and services in U.S. dollars. For those orders denominated in foreign currencies, we may limit our exposure to losses from foreign currency transactions through forward foreign exchange contracts. To date, sales denominated in foreign currencies have not been significant and we have not entered into any foreign exchange contracts.

Employees

As of April 22, 2003, we employed approximately 143 employees. We believe our employee relations to be good. The majority of our employees are professional or technical personnel who possess training and experience in engineering, computer science, and management. Our future success depends in large part on our ability to retain key technical, marketing, and management personnel, and to attract and retain qualified employees, particularly those highly skilled radio frequency, design, process, and test engineers involved in the development of new products. Competition for such personnel is intense, and the loss of key employees, as well as the failure to recruit and train additional technical personnel in a timely manner, could have a material adverse effect on our operating results.

Our success depends to a significant extent upon the contribution of our executive officers and other key employees. We have an employee stock option plan whereby key employees can participate in our success.

Risk Factors and Uncertainties

Described below and elsewhere in this report and in other documents we file with the SEC, press releases, and other communications are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this report.

Market and Industry Risk

A significant portion of our annual revenue is derived from customers of our wireless test solutions business. These customers include national and regional wireless carriers throughout the world, as well as equipment vendors and others. During the past serveral years, wireless carriers experienced many challenges that have resulted in a decline in both capital spending and demand for our wireless test solutions products. With reduced availability of capital and the transition to next-generation technologies, plans, projects, and capital spending are subject to frequent change as wireless carriers reevaluate and reorder their priorities. As a result, revenue from our wireless test solutions business for fiscal 2003 continued to be soft. Additionally, the spending patterns of our customers are increasingly volatile and difficult to predict, which makes it very difficult for us to forecast the demand for our wireless test solution products. The extent of this downturn and how long it will last is unknown. No assurance can be given that our revenue and operating results will not be further adversely affected by the current or future downturns in the wireless industry and the markets into which we sell our products.

Worldwide Economic and Market Conditions

We currently maintain sales and support operations in the United States, Europe, Asia, and Latin America. Accordingly, our business is subject to the worldwide economic and market conditions and risks generally associated with doing business abroad, such as fluctuating exchange rates, the stability of international monetary conditions, tariff and trade policies, domestic and foreign tax policies, foreign governmental regulations, political unrest, disruptions or delays in shipments, and changes in other economic conditions. These factors, among others, could influence our ability to sell in international markets. A significant downturn in the global economy could adversely affect our operating results.

Additionally, we have limited experience selling our products in markets outside North America. However, it is currently our intention to expand our international presence and establish additional sales

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and support offices in primary international markets. There can be no assurance given that our international sales efforts will be successful.

Competition

We encounter aggressive competition in our wireless test solutions business. We have numerous competitors for products from some of the world’s largest corporations to many relatively small and highly specialized firms. We compete primarily on the basis of technology, domain expertise, performance, price, quality, reliability, customer service, and support. Some of our competitors have greater resources to apply to each of these factors and in some cases have built significant reputations with the customer base in the markets in which we compete. If we are unable to successfully compete, it could have a material adverse effect our business, financial condition, and operating results.

Quarterly Fluctuations in Operating Results

We have experienced, and expect to continue to experience, significant quarterly fluctuations in revenue and operating results for our wireless test solutions business. Our quarterly operating results are impacted by numerous factors, including:

Due to these and other factors, our past results are not reliable indicators of our future performance. Future revenue and operating results may not meet the expectations of public market analysts and investors. In either case our stock price could be materially adversely affected.

Ability to Forecast Operating Results

Due to the downturn in the wireless industry, the spending patterns of our customers are increasingly volatile and difficult to predict, which makes it very difficult for us to forecast the demand for our wireless test solutions products. Significant portions of our costs are fixed, due in part to our significant sales, engineering and product support, and manufacturing organizations. As a result, relatively small declines in revenue could disproportionately affect our operating results. Additionally, we have limited backlog and a limited view of when an order will be received and shipped, which may affect revenue in any given period.

Product Demand and Manufacturing Capacity

As we are limited in our ability to quickly adapt our production and related cost structures to rapidly changing market conditions, customer demand that does not meet our expectations will result in excess manufacturing capacity. The fixed costs associated with excess capacity will adversely affect our operating results. Conversely, if our manufacturing capacity does not keep pace with customer demand, we will not be able to fulfill orders in a timely manner, which in turn may have a negative effect on our operating results.

We maintain one manufacturing facility in Irvine, California. Any significant disruption in our manufacturing operation, whether due to fire, natural disaster, or otherwise, will have a material adverse effect on our financial condition and operating results.

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Supplier Risk

We currently procure, and expect to continue to procure, certain components from single source manufacturers due to unique component designs, as well as certain quality and performance requirements. In addition, in order to take advantage of volume pricing discounts, we purchase certain customized components from single sources. We have experienced, and may in the future experience, shortages of single-source components. In such event, we may have to make adjustments to both product designs and production schedules that could result in delays in production and delivery of products. Such delays could have a material adverse effect on our financial condition and operating results.

New Product Introductions

We sell our products in the wireless industry, as well as the consumer electronics industry, which are characterized by rapid technological changes, frequent new product introductions, and evolving industry standards. Without the timely introduction of new products and enhancements, our products will likely become technologically obsolete over time, in which case our operating results would suffer. The success of our new product offerings will depend on several factors, including our ability to:

Development of new products may require a substantial investment before we can determine the commercial viability of these innovations. We would suffer competitive harm if we dedicate a significant amount of resources to the development of products that do not achieve broad market acceptance.

Product Defects

Our products may have defects despite testing internally or by third-party labs. These defects could result in product returns or recalls and loss or delay in market acceptance, which could have a material adverse effect upon our business, operating results, or financial condition.

Early in fiscal 2004 and in cooperation with the U.S. Consumer Product Safety Commission (“CPSC”), we announced a voluntary product safety recall of approximately 125,000 detachable plugs used on our ChargeSource 70-watt universal AC power adapter. The detachable AC plug can crack if the plug’s swivel connector is extended beyond the 90 degrees of allowed rotation, creating the potential for electric shock. To date, no injuries have been reported. Approximately 75,000 units are believed to be in consumer’s hands, while another 50,000 are currently in the distribution channel. In conjunction with the product safety recall, the Company and Targus entered into an agreement addressing the impact of the recall action. Due to the recall action and the agreement with Targus, we have accrued a $3.2 million credit to Targus as a reduction of sales and additional recall costs of approximately $0.6 million classified in cost of revenue in the fourth quarter of fiscal 2003. Actual amounts may differ materially from our current estimates based on many factors, including the number of qualifying 70-watt universal adapters returned to Comarco by Targus and their customers, primarily consumer electronics retailers.

Short Product Life Cycles

The short life cycles of many of our products pose a challenge for us to manage effectively the transition from existing products to new products. If we do not manage the transition effectively, our operating results could suffer. Among the factors that make a smooth transition from current products to new products difficult are delays in product development or manufacturing, variations in product costs, and delays in customer purchases of existing

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products in anticipation of new product introductions. Our operating results could also suffer due to the timing of product introductions by our competitors. This is especially true when a competitor introduces a new product just before our own product introduction.

Intellectual Property

We generally rely upon patent, copyright, trademark, and trade secret laws in the United States and in certain other countries, and agreements with our employees, customers, and partners to establish and maintain our proprietary rights in our technology and products. However, any of our intellectual proprietary rights could be challenged, invalidated, or circumvented. Our intellectual property may not necessarily provide significant competitive advantages. Also, because of the rapid pace of technological change in the wireless industry, certain of our products rely on key technologies developed by third parties and we may not be able to continue to obtain licenses from these third parties. Third parties may claim that we are infringing their intellectual property. Even if we do not believe that our products are infringing third parties’ intellectual property rights, the claims can be time-consuming and costly to defend and divert management’s attention and resources away from our business. Claims of intellectual property infringement might also require us to enter into costly royalty or license agreements. If we cannot or do not license the infringed technology or substitute similar technology from another source, our business could suffer.

Integration Risks

In the normal course of business, we frequently engage in discussions with third parties relating to possible acquisitions, strategic alliances, and joint ventures. Although completion of any one transaction may not have a material effect on our financial position, results of operations, or cash flows taken as a whole, our financial results may differ from the investment community’s expectations in a given quarter. Acquisitions and strategic alliances may require us to integrate with a different company culture, management team, and business infrastructure. We may also have to develop, manufacture, and market products in a way that enhances the performance of the combined business or product line. Depending on the size and complexity of an acquisition, our successful integration of the entity depends on a variety of factors, including:

All of these efforts require varying levels of management resources, which may divert our attention from other business operations.

Stock Price

Our stock price has exhibited significant volume and price fluctuations, which makes our stock unsuitable for many investors. In addition, the stock market has from time to time experienced significant price and volume fluctuations. The fluctuations in the stock market are often unrelated to the operating performance of particular companies, and the market prices for securities of technology companies have been especially volatile. These broad market fluctuations may adversely affect the market price of shares of our Common Stock. Our stock price may be affected by the factors discussed above, as well as:

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Our headquarters and primary manufacturing facility is located in Irvine, California. This leased facility consists of approximately 42,000 square feet of office space and approximately 8,000 square feet of manufacturing/ warehouse space. The lease for this facility expires in August 2004. We also lease office space and, in some instances, warehouse space in California, Maryland, New York, Oregon, Texas, Mexico, and Singapore. The leases on these facilities expire at various times through February 2007.

Mobility Electronics, Inc. v. Comarco, Inc. and Comarco Wireless Technologies, Inc., Case No. CIV-01-1489-PHX-MHM, U.S. District Court for the District of Arizona (“Mobility Arizona Action”):

Mobility Electronics, Inc. (“Mobility”) commenced proceedings as to U. S. Patent No. 5,347,211 (“the ‘211 Patent”) for patent infringement against the Company and Comarco Wireless Technologies, Inc. (“CWT”) with respect to CWT’s ChargeSource power supply products. The Company was first served with Mobility’s amended complaint filed August 10, 2001. In addition to asserting that the Company and CWT have infringed the ‘211 patent, the amended complaint seeks declaratory judgment that three of CWT’s power supply related patents are either invalid or not infringed by power supplies produced or to be produced by Mobility. The three CWT patents are U. S. Patent Nos. 6,091,611 (“the ‘611 Patent”), 6,172,884 (“the ‘884 patent”), and 5,838,554 (“the ‘554 patent”). The Company and CWT believe that they have meritorious defenses with respect to the ‘211 patent and Mobility’s declaratory judgment causes of actions.

A Scheduling Conference was held on December 18, 2002. Following that Conference, the Court entered its Scheduling Order granting the parties until June 15, 2004 to conduct discovery, and until June 30, 2004 to file dispositive motions. Following resolution of any dispositive motions, or following the deadline for filing if no such motions are filed, the Court will hold a status hearing for purposes of selecting a firm trial date and related pre-trial deadlines.

On October 28, 2002, the California District Court hearing the matter of Comarco Wireless Technologies, Inc. v. Xtend Micro Products, Inc. and iGo Corporation, former Case No. SACV 02-640 AHS (ANx) (discussed below), ordered the California Action transferred to the District of Arizona. The Arizona Court on January 31, 2003, further ordered the action consolidated with the Mobility Arizona Action for purposes of discovery.

Also, as discussed below, CWT recently filed a separate suit in Arizona against Mobility and two affiliated entities alleging infringement of Comarco’s ‘611 and ‘884 Patents (“CWT Arizona Action”). The CWT Arizona Action has been consolidated for purposes of discovery with the Mobility Arizona Action.

Comarco Wireless Technologies, Inc. v. Xtend Micro Products, Inc. and iGo Corporation, Case No. 02:2201 PHX MHM, U.S. District Court for the District of Arizona (formerly, SACV 02-640 AHS (ANx), U.S. District Court for the Central District of California, Southern Division):

On June 21, 2002, CWT filed this action for patent infringement against Xtend Micro Products, Inc. (“Xtend”) and its parent entity, iGo Corporation (“iGo”). CWT alleges that its ‘611 and ‘884 patents are infringed by Xtend’s PowerXtender^™ and AC Adapter power supply products as well as other power supply and power adapter products and related accessories. On July 15, 2002, Xtend and iGo answered the complaint denying the allegations in CWT’s complaint and asserting a number of affirmative defenses.

In September, 2002, Defendants moved to transfer this action to the Arizona District Court for purpose of consolidation with the Mobility Arizona Action because this case involved two overlapping patents, and because defendants iGo/Xtend were acquired by and merged into a wholly-owned subsidiary of Mobility. On October 28,

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2002 the California District Court granted the Motion and Ordered that the case be transferred to the District of Arizona.

On January 31, 2003, the Arizona Court adopted its Scheduling Order for the case and separately ordered that the case be consolidated for purposes of discovery with the Mobility Arizona Action. Pursuant to the Scheduling Order, the parties have until June 15, 2004 to conduct discovery, and dispositive motions are to be filed by June 30, 2004. The Court will hold a status conference following resolution of any dispositive motions or, if none are filed, following the passing of the June 30, 2004 deadline. At that time, the Court will adopt a firm trial date and set related pre-trial deadlines.

Comarco Wireless Technologies, Inc. v. Mobility Electronics, Inc., Hipro Electronics Co., Ltd., and iGo Corporation, Case No. 03:202 PHX MHM, United States District Court, District of Arizona

On January 31, 2003, CWT filed this action for infringement of its ‘611 and ‘884 Patents with regard to a universal power adapter, called “Juice.” Defendant Hipro manufactures Juice for Mobility, which in turn offers it for sale through its wholly owned subsidiary, iGo Corp. On February 27, 2003, Mobility and iGo answered the complaint while Hipro filed a motion to dismiss based on lack of personal jurisdiction and improper service.

On March 4, 2003, CWT filed a Motion for Preliminary Injunction seeking to enjoin Mobility, Hipro and iGo from making, using, selling or offering for sale the “Juice” product. The Court has set a June 12, 2003 hearing date for both CWT’s Motion for Preliminary Injunction and Hipro’s Motion to Dismiss. Additionally, the parties have agreed to participate in a settlement conference before a United States Magistrate Judge on May 20, 2003.

CWT believes that its case against Mobility, Hipro and iGo Corp is meritorious. As described above, this action has been consolidated for purposes of discovery with the Mobility Arizona Action.

Los Angeles County Service Authority for Freeway Emergencies v. Comarco Wireless Technologies, Inc., Case No. SACV 02-567 AHS (ANx), U.S. District Court for the Central District of California, Southern Division:

Los Angeles County Service Authority for Freeway Emergencies (“LASAFE”) filed this action against CWT on June 10, 2002, relating to two contracts between LASAFE and CWT concerning Call Box Systems manufactured by CWT, upgraded by CWT to comply with the Americans with Disabilities Act (“ADA”) and maintained by CWT until its contractual obligations to provide maintenance expired. On August 2, 2002, LASAFE filed a first amended complaint (hereafter, “the complaint”). The complaint includes eight counts. In the first five counts LASAFE alleges CWT breached its contractual obligations and implied warranties by failing to properly maintain and repair the call box system and failing to provide certain deliverables to LASAFE. In the last three counts LASAFE alleges that U.S. Patent No. 6,035,187 owned by CWT and entitled “Apparatus and Method for Improved Emergency Call Box” (“the ‘187 Patent”) should be assigned to LASAFE, and CWT should compensate LASAFE, because an LASAFE employee is the true inventor of the invention claimed in the ‘187 Patent. The complaint seeks an unspecified amount of actual and punitive damages, ownership of the ‘187 patent, an order that CWT specifically perform its obligations under the contracts, recovery of attorneys fees, and an audit to determine the number of allegedly infringing call boxes.

On August 16, 2002, CWT filed an answer and a motion to dismiss the first five counts founded in state contract and warranty law on the grounds that the Federal District Court lacks jurisdiction over the state law claims, which was subsequently granted. The Court has set a scheduling order and has set a trial date of February 3, 2004. CWT believes that it has meritorious defenses with respect to all of LASAFE’s claims.

Los Angeles County Service Authority for Freeway Emergencies v. Comarco Wireless Technologies, Inc., Case No. No. BC 284897, California Superior Court for the County of Los Angeles:

On November 7, 2002, LASAFE filed a complaint in state court alleging the five causes of action that were dismissed in the federal court action referenced in the above paragraph. Specifically, LASAFE alleges that CWT breached its contractual obligations and implied warranties by failing to properly maintain and repair the call box systems and failing to provide certain deliverables to LASAFE, and seeks over $1 million in damages. On January 9,

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2003, CWT filed its answer and a cross-complaint asserting causes of action for breach of contract and breach of the implied covenant of good faith and fair dealing based on LASAFE’s failure to pay CWT all monies due under a contract with LASAFE and LASAFE’s conduct during the course of the contract. LASAFE has not yet responded to CWT’s cross-complaint. The Court has set a trial date of April 5, 2004. CWT believes that it has meritorious defenses to LASAFE’s claims and believes that LASAFE will have significant difficulties proving causation and damages on its claims for breach of implied warranties.

We are from time to time involved in various legal proceedings incidental to the conduct of our business. We believe that the outcome of all other such pending legal proceedings will not in the aggregate have a material adverse effect on our financial condition and operating results.

No matter was submitted during the fourth quarter ended January 31, 2003 to a vote of our security holders.

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PART II

Market Information

Our common stock is traded on the Nasdaq National Market^® under the symbol “CMRO.” The following table sets forth for the periods indicated the quarterly high and low closing prices per share as reported by the Nasdaq National Market. These prices represent actual reported sales transactions.

Holders

As of April 22, 2003, there were approximately 405 holders of record of our common stock.

Dividends

We have not paid any cash dividends on our common stock in the last two fiscal years. We anticipate that dividends on our common stock will not be paid for the foreseeable future and that all earnings will be retained for use in our business and for stock repurchases.

Sales of Unregistered Securities

In connection with our acquisition of EDX Engineering, Inc. (“EDX”) on December 7, 2000, we issued 257,428 shares of common stock and approximately $2.3 million in cash to the former sole shareholder of EDX in exchange for all of the outstanding shares of capital stock of EDX. These shares were issued in reliance on the exemption provision provided under Section 4(2) of the Securities Act of 1933, as amended.

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The discussion that follows provides analysis and information that management believes is relevant to an assessment and understanding of our consolidated results of operations and financial condition. The following discussion and analysis should be read in conjunction with our consolidated financial statements and accompanying notes thereto included in Part II, Item 8 of this report, and the section entitled “Risk Factors and Uncertainties” included in Part I, Item 1 of this report.

Overview

Comarco, Inc., through its subsidiary Comarco Wireless Technologies, Inc. (collectively, “we,” “Comarco,” or the “Company”), is a leading provider of wireless test solutions for the wireless industry. Comarco also designs and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices. During October 1999, we embarked on a plan to divest our non-wireless businesses, which included the defense and commercial staffing businesses. The divestiture plan was completed during November 2000. Accordingly, our continuing operations consist solely of the operations of Comarco Wireless Technologies, Inc. (“CWT”).

Results of Operations — Continuing Operations

We have two reportable operating segments: wireless test solutions and wireless applications. See “Segment Reporting” in Note 2 of Notes to Consolidated Financial Statements in Part II, Item 8 of this report.

Wireless Test Solutions

Our wireless test solutions business designs and manufactures hardware and software tools for use by wireless carriers, equipment vendors, and others. Radio frequency engineers, professional technicians, and others use these field test applications to design, deploy, and optimize wireless networks, and to verify the performance and quality of service delivered by the networks once deployed.

Beginning in fiscal 2002 and after several years of robust growth, the wireless industry deteriorated, reflecting slowing subscriber growth, intensifying price competition, reduced access to capital and the need to manage cash flow. This trend continued through fiscal 2003 and there are few indications that this trend will not continue into fiscal 2004. Wireless carriers have responded to these challenges by reducing capital spending and focusing on projects that can most directly contribute to their revenue. Wireless carriers are now focused on satisfying customer demand for enhanced data services, seamless and comprehensive coverage, improved quality of service, and faster data transmission. Many of these initiatives require capital spending for additional network capacity and next-generation technologies, also referred to as 2.5G and 3G technologies. With reduced availability of capital and the transition to next-generation technologies, plans, projects, and capital spending are subject to frequent change as wireless carriers reevaluate and reorder their priorities. As a result, demand for our 2G wireless test solutions products has significantly decreased and the spending patterns of the wireless carriers continue to be volatile and difficult to predict.

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In response to these challenging market conditions, we restructured our wireless test solutions business to better address the future needs of our customers and improve our financial performance in markets currently under pressure. Key changes made to our wireless test solutions business in fiscal 2003 are as follows:

Wireless Applications

Our wireless applications business designs and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices. Our call box products provide emergency communication over existing wireless networks. In addition to the call box products, we provide system installation and long-term maintenance services. Currently, we have approximately 14,000 call boxes installed, the majority of which are serviced and maintained under long-term agreements.

The wireless applications business also includes the ChargeSource family of mobile power products. Our current offering of ChargeSource products consist of a 70-watt universal AC power adapter, our second-generation mobile power system. By simply changing the compact SmartTips connected to the end of the charging cable, the universal AC power adapter is capable of charging and powering multiple target devices, including most notebook computers, cellular telephones, PDAs, and other handheld devices. During the third quarter of fiscal 2002, the ChargeSource product offering was expanded with the introduction of the 70-watt universal DC power adapter. This universal DC power adapter allows traveling professionals to use all their existing ChargeSource SmartTips on the road or in the air. This device connects to the in-seat power outlet available on most major airlines or the cigarette lighter plug found in automobiles. Targus currently distributes both these products.

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Until recently, most notebook computers required no more than 70-watts of power to operate. However, the personal computer industry is currently transitioning to notebook computers with increasing power requirements. As the power requirements increase, so does the size of the original equipment manufacturer (“OEM”) AC charger sold with the notebook computer. To address this industry wide trend, we have developed 120-watt universal power adapters that are compatible with all legacy, current, and future notebook computers. These new ChargeSource products are able to deliver up to 120-watts of power in a very small form factor. The new ChargeSource product family, which is expected to begin shipping during the second quarter of fiscal 2004, consists of the following:

The above products work with existing Smart Tips and are backwards compatible with the 70-watt adapters, which are expected to be phased out of production during the first quarter of fiscal 2004.

Early in fiscal 2004 and in cooperation with the U.S. Consumer Product Safety Commission (“CPSC”), we announced a voluntary product safety recall of approximately 125,000 detachable plugs used on our ChargeSource 70-watt universal AC power adapter. The detachable AC plug can crack if the plug’s swivel connector is extended beyond the 90 degrees of allowed rotation, creating the potential for electric shock. To date, no injuries have been reported. Approximately 75,000 units are believed to be in consumer’s hands, while another 50,000 are currently in the distribution channel. In conjunction with the product safety recall, the Company and Targus entered into an agreement addressing the impact of the recall action. Due to the recall action and the agreement with Targus, we have accrued a $3.2 million credit to Targus as a reduction of sales and additional recall costs of approximately $0.6 million classified in cost of revenue in the fourth quarter of fiscal 2003. Actual amounts may differ materially from our current estimates based on many factors, including the number of qualifying 70-watt universal adapters returned to Comarco by Targus and their customers, primarily consumer electronics retailers.

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The following table sets forth certain items as a percentage of revenue from our audited consolidated statements of income for fiscal 2003, 2002, and 2001:

Consolidated

Revenue

Total revenue for fiscal 2003 was $36.8 million compared to $51.0 million for fiscal 2002, a decrease of approximately $14.2 million or 27.8 percent. As discussed below, the decrease is attributable to decreased sales of our wireless test solution products and services, partially offset by increased sales of our wireless applications products. Total revenue for fiscal 2002 was $51.0 million compared to $49.5 million for fiscal 2001, an increase of approximately $1.5 million or 3.1 percent. The increase is due to a $6.5 million increase in sales of our wireless applications products, partially offset by a 5.0 million decrease in sales of our wireless test solution products.

For fiscal 2003 as compared to the prior year, revenue from products decreased 18.8 percent to $31.5 million while revenue from services decreased 56.3 percent to $5.3 million. The product revenue decrease reflects the continuing softness in the wireless industry and decreased demand for our wireless test solution products, which declined $11.6 million or 53.1 percent, offset by an increase in sales of our ChargeSource products of $3.6 million or 31.1 percent, net of a $3.2 million credit issued to our exclusive distributor in conjunction with the product safety recall of our 70-watt universal ChargeSource power adapter. See the section entitled “ChargeSource Product Safety Recall” for additional discussion. The services revenue decrease was due to our exit from the engineering services business during the second quarter of fiscal 2003. Revenue from engineering services totaled $0.9 and $7.5 million for fiscal 2003 and 2002, respectively.

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For fiscal 2002 as compared to the prior year, revenue from products increased 3.6 percent to $38.8 million while revenue from services increased 1.6 percent to $12.2 million. The product revenue growth was due to increased sales from our wireless applications segment, partially offset by decreased sales from our wireless test solutions segment. The services revenue growth was due to increased sales of engineering services from our wireless test solutions segment.

Cost of Revenue and Gross Margin

Total cost of revenue for fiscal 2003 was $24.6 million compared to $25.7 million for fiscal 2002, a decrease of approximately $1.1 million or 4.3 percent. Cost of revenue for fiscal 2003 included a non-cash inventory impairment charge, totaling approximately $1.3 million. This inventory impairment charge is attributable to our wireless test solutions business. See the section below entitled “Asset Impairment Charges” for additional discussion. Cost of revenue for fiscal 2003 also included approximately $0.6 million of costs accrued in connection with the product safety recall of our ChargeSource 70-watt universal power adapters. See the section below entitled “ChargeSource Product Safety Recall” for additional discussion. Excluding the inventory impairment and product safety recall charges, total cost of revenue for fiscal 2003 was $22.8 million. As a percentage of revenue, gross margin for fiscal 2003 decreased to 38.2 percent compared to 49.7 percent for the prior fiscal year. As discussed below, the decrease in gross margin was primarily due to a change in our mix of business, our exit from engineering services, and the negative effect of significantly reduced sales and decreasing gross margins of our historically higher margin wireless test solution products.

Total cost of revenue for fiscal 2002 increased 3.4 percent to $25.7 million compared with fiscal 2001. As a percentage of revenue, gross margin decreased slightly to 49.7 percent from 49.8 percent for fiscal 2001. While the gross margin for fiscal 2002 was comparable to the prior year, it was a result of increased sales volumes and margins of our wireless applications products offset by decreased sales volumes and margins of our wireless test solution products.

Selling, General and Administrative Costs

Selling, general and administrative costs for fiscal 2003 were $9.1 million compared to $12.7 million for the prior fiscal year, a decrease of $3.6 million or 28.6 percent. This decrease was due to reduced staffing levels, selling expenses, and incentive compensation driven by significantly reduced sales of our wireless test solution products and services. Additionally, as of February 1, 2002 and in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” we no longer amortize goodwill and other intangible assets deemed to have indefinite lives. For fiscal 2002, selling, general and administrative costs included $1.1 million of amortization of goodwill and other intangible assets deemed to have indefinite lives.

Selling, general and administrative costs for fiscal 2002 increased 3.2 percent to $12.7 million compared to fiscal 2001. Excluding costs attributable to EDX Engineering, Inc. (“EDX”), which was acquired on December 7, 2000, selling, general and administrative costs for fiscal 2002 decreased $1.2 million in comparison to the prior year. This decrease was driven by lower sales of our wireless test solutions products during fiscal 2002, as well as enterprise-wide cost reductions that were put in place during fiscal 2001. These cost reductions, including eliminating direct sales and marketing efforts for our ChargeSource mobile power products, closing the sales and support office in London, and reorganizing our call box systems business, resulted in a significant reduction of indirect costs.

As a percentage of revenue, selling, general and administrative costs were 24.6 percent, 24.9 percent, and 24.8 percent for fiscal 2003, 2002, and, 2001, respectively.

Asset Impairment Charges

Due to reduced demand for existing wireless test solutions products in the wireless marketplace and our strategy of investing available resources in the development of Seven.Five, our new product platform, we have analyzed the carrying value of all assets attributable to our wireless test solutions business. Based on this analysis, we

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recorded asset impairment charges totaling $8.4 million during the second quarter of fiscal 2003. The following table sets forth the impaired assets and corresponding impairment charges (in thousands):

In addition to the asset impairment charges above, an inventory impairment charge totaling $1.3 million was recorded as cost of revenue during the second quarter of fiscal 2003. The above impaired assets, as well as the inventory impairment charge are exclusively related to our legacy 2G wireless test solutions products and do not include any assets related to our engineering services business, which ceased operations during the second quarter of fiscal 2003.

Cumulative Effect of Accounting Change

As discussed in Note 11 of the accompanying financial statements, the Company adopted SFAS No. 142 “Goodwill and Other Intangible Assets” effective February 1, 2002. During the second quarter of fiscal 2003, we completed the required transitional impairment test under the new rules and recorded a non-cash charge of $2.9 million to write down fully the carrying value of the goodwill related to our EDX software reporting unit. This reporting unit is included in our wireless test solutions segment for financial reporting purposes, and the related goodwill was generated through our acquisition of EDX Engineering, Inc. during December 2000. Such charge is reflected as a cumulative effect of accounting change. In calculating the impairment charge, the fair value of the impaired reporting unit underlying the wireless test solutions segment was estimated using a discounted cash flow methodology. This charge writes off the entire carrying value of the recorded goodwill and accordingly, $2.9 million was recorded as a cumulative charge for the fiscal year ended January 31, 2003. No comparable charge was recorded during the corresponding period of the prior fiscal year.

ChargeSource Product Safety Recall

As discussed above, early in fiscal 2004 and in cooperation with the U.S. CPSC, we announced a voluntary product safety recall of approximately 125,000 detachable plugs used on our ChargeSource 70-Watt universal AC power adapter. In conjunction with the product safety recall, the Company and Targus, exclusive distributor of the ChargeSource products, entered into an agreement addressing the impact of the recall action. Accordingly, we have accrued both a $3.2 million credit due to Targus reducing sales and additional recall costs of approximately $0.6 million classified in cost of revenue in the fourth quarter of fiscal 2003.

Engineering and Support Costs

The Company capitalizes costs incurred for the development of software embedded in our wireless test solutions products that will be sold when technological feasibility has been established. These capitalized costs are subject to an ongoing assessment of recoverability based on anticipated future revenue and changes in hardware and software technologies. Costs that are capitalized include direct labor and related overhead.

Engineering and support costs for fiscal 2003 and 2002 are as follows:

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Engineering and support costs, net of capitalized software development costs, for fiscal 2003 were $5.9 million compared to $5.7 million for the prior fiscal year, an increase of approximately $0.2 million. Gross engineering and support costs, before reduction for capitalized software development costs, decreased $1.9 million in comparison to fiscal 2002. This decrease is a result of our strategy of reducing the cost structure supporting our wireless test solutions business and developing a single flexible product platform. Offsetting this cash savings and consistent with the reduction in the number of on-going software development programs, capitalized software development costs decreased $2.1 million resulting in an increase in engineering and support costs, net of capitalized software development costs, of $0.2 million for fiscal 2003 in comparison to the prior fiscal year.

Engineering and support costs for fiscal 2002 and 2001 are as follows:

Engineering and support costs, net of capitalized software development costs, for fiscal 2002 increased 20.7 percent to $5.7 million compared to fiscal 2001. Excluding costs attributable to EDX, engineering and support costs net of capitalized software development for fiscal 2002 were $5.0 million compared to $4.7 million for fiscal 2001, an increase of $0.3 million or 6.4%. This increase was partially offset by increased capitalized software development costs totaling $5.5 million and $4.6 million for fiscal 2002 and 2001, respectively. The increases in gross engineering and capitalized software development costs were primarily due to continued investment in our hardware and software product development programs, which included GPRS and 1XRTT products (2.5G technologies), as well as 3G scanners and related applications.

Severance Costs

During the second quarter of fiscal 2001 and in conjunction with the disposition of our non-wireless businesses, we were required to record a $1.3 million charge to continuing operations for costs related to severance agreements for outgoing corporate staff. No similar costs were recorded in fiscal 2003 and 2002.

Other Income

Other income, consisting primarily of interest income, decreased approximately $0.5 million to $0.4 million for fiscal 2003 compared to the prior fiscal year. This decrease was primarily due to lower interest rates earned on invested cash balances. Other income increased $150,000 to $0.9 million for fiscal 2002 compared to fiscal 2001, primarily as a result of higher invested cash balances for much of the fiscal year.

Income Tax Expense

The effective tax rate for fiscal 2003, 2002, and 2001 was 28.1 percent, 36.8 percent, and 35.3 percent, respectively. The decrease in the effective tax rate used to compute the income tax benefit for fiscal 2003 is due to permanent differences in our taxable loss for fiscal 2003 as a result of non-deductible intangible asset impairment charges.

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Wireless Test Solutions

Revenue

Wireless test solutions revenue for fiscal 2003 was $11.2 million compared to $29.6 million for fiscal 2002, a decrease of approximately $18.4 million or 62.1 percent. This decrease reflects the reduced demand for our legacy 2G wireless test solution products, as well as engineering services, which we ceased providing during the second quarter of fiscal 2003. Revenue from engineering services for fiscal 2003 and 2002 totaled $0.9 million and $7.5 million, respectively.

For fiscal 2003, 2002, and 2001, customers of our wireless test solutions business accounted for 30.5 percent, 58.2 percent, and 70.1 percent, respectively, of our annual revenue, and 30.0 percent, 66.0 percent, and 82.6 percent, respectively, of our annual gross profit. Due to the uncertainties associated with the spending patterns of our customers and the corresponding demand for our wireless test solution products, we have experienced and expect to continue to experience significant fluctuations in demand. Such fluctuations have caused and may continue to cause significant reductions in revenue and/or operating income, negatively affecting our business, financial condition, and operating results. We are currently unable to predict when the downturn in the wireless industry will cease to have a negative impact on our revenues and operating results.

Revenue from our wireless test solutions business for fiscal 2002 was $29.7 million, a decrease of $5.0 million or 14.5 percent compared to fiscal 2001. As previously discussed, the downturn in the wireless industry, which first impacted us in early fiscal 2002, reduced overall demand for our wireless test solution products.

Cost of Revenue and Gross Margin

Wireless test solutions cost of revenue for fiscal 2003 was $7.6 million compared to $12.9 million for fiscal 2002, a decrease of approximately $5.4 million or 41.5 percent. As discussed above, during fiscal 2003, we recorded a non-cash inventory impairment charge totaling approximately $1.3 million. Excluding this asset impairment charge, wireless test solutions cost of revenue for fiscal 2003 was $6.3 million. As a percentage of revenue, gross margin for fiscal 2003 decreased to 32.7 percent compared to 56.4 percent for the prior fiscal year. The decrease in gross margin is primarily due to decreased absorption of fixed costs attributable to dramatically lower revenue.

Cost of revenue from our wireless test solutions business for fiscal 2002 was $12.9 million, a decrease of $1.4 million or 9.7 percent compared to fiscal 2001. As a percentage of revenue, gross margin decreased to 56.4 percent from 58.7 percent for fiscal 2001. The decrease in cost of revenue was primarily due to decreased sales volumes of hardware and software tools. The decrease in gross margin is attributable to decreased absorption of manufacturing overhead expenses and increased labor costs, when viewed as a percentage of revenue, driven by lower sales of our hardware and software tools.

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Wireless Applications

Revenue

Wireless applications revenue for fiscal 2003 was $25.6 million compared to $21.3 million for fiscal 2002, an increase of approximately $4.3 million or 20.0 percent. This increase was primarily due to increased sales of our ChargeSource mobile power products. Our combined ChargeSource sales increased approximately $3.6 million to $15.2 million for fiscal 2003, net of the $3.2 million credit issued to our exclusive distributor in conjunction with the product safety recall of our ChargeSource 70-watt universal AC power adapter, as discussed above.

Wireless applications revenue for fiscal 2002 was $21.3 million, an increase of $6.6 million or 44.4 percent compared to fiscal 2001. The increase was attributable to increased sales of the ChargeSource 70-watt universal AC power adapter, our second-generation mobile power system that began shipping during the fourth quarter of fiscal 2001, and the introduction of the new ChargeSource 70-watt universal DC power adapter that began shipping during the third quarter of fiscal 2002.

Both ChargeSource products are currently distributed exclusively by Targus under non-cancelable commitments. In the event Targus is unable to perform under these commitments due to their inability to take delivery of ordered products and/or pay for such products in a timely manner, we would be required to establish alternative distribution channels. The financial impact of a material change in our relationship with Targus cannot be precisely quantified, but we believe that a six-to-twelve month disruption in the distribution of our ChargeSource products would have a negative impact on our revenue and operating results, which could also result in decreased liquidity. For fiscal 2003, 2002, and 2001, sales to Targus totaled approximately $15.1 million, $11.3 million, and $4.8 million, respectively.

Cost of Revenue and Gross Margin

Wireless applications cost of revenue for fiscal 2003 was $17.0 million compared to $12.7 million for fiscal 2002, an increase of $4.3 million or 33.5 percent. Excluding the cost of the product safety recall, cost of revenue for fiscal 2003 was $16.4 million. As a percentage of revenue and excluding the credit and costs associated with the product safety recall, gross margin for fiscal 2003 increased to 43.0 percent from 40.3 percent for fiscal 2002. The increase in wireless applications gross margin is primarily attributable to several higher-margin call box upgrade projects completed during fiscal 2003.

Cost of revenue of our wireless applications business for fiscal 2002 was $12.7 million, an increase of $2.2 million or 21.3 percent compared to fiscal 2001. As a percentage of revenue, gross margin increased to 40.3 percent from 29.0 percent for fiscal 2001. The increase in cost of revenue was primarily due to increased sales volumes of our ChargeSource mobile power products.

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Discontinued Operations

As discussed above, we embarked on a plan to divest our non-wireless businesses, which included the defense and commercial staffing businesses. The divestiture plan was completed during November 2000.

Net loss from discontinued operations was $9,000 for fiscal 2001, which includes net income during phase-out of $348,000 on revenue of $21.7 million, less an after-tax loss of $357,000 on the disposition of our non-wireless businesses.

Liquidity and Capital Resources

Our financial position remains strong, with cash and cash equivalents of $25.4 million as of January 31, 2003.

Cash Flows from Operating Activities

Cash provided by operating activities is primarily derived from the sale of our products and services. Cash provided by operating activities was $10.0 million and $8.1 million for the years ended January 31, 2003 and 2002, respectively.

Cash provided by operating activities during the year ended January 31, 2003 was primarily a result of our net income from continuing operations before non-cash charges (including cumulative effect of accounting change, asset impairment charges, provision for obsolete inventory, and depreciation and amortization), collection of $7.7 million of accounts receivable offset by a net change in deferred income taxes of $2.7 million, a decrease in current liabilities of $2.4 million, and an increase in both inventory and other assets of $1.2 million each.

Early in fiscal 2004 and in cooperation with the U.S. CPSC, we announced a voluntary product safety recall of approximately 125,000 detachable plugs used on our ChargeSource 70-watt universal AC power adapter. The detachable AC plug can crack if the plug’s swivel connector is extended beyond the 90 degrees of allowed rotation, creating the potential for electric shock. To date, no injuries have been reported. Approximately 75,000 units are believed to be in the hands of consumers, while another 50,000 are currently in the distribution channel.

In conjunction with the product safety recall, the Company and Targus entered into an agreement addressing the impact of the recall action. Due to the recall action and the agreement with Targus, we have accrued a $3.2 million credit to Targus as a reduction of sales and additional recall costs of approximately $0.6 million classified in cost of revenue in the fourth quarter of fiscal 2003. The credit to Targus is based on unsold and unopened units in the distribution channel expected to be returned to us within a six-month period. The accrued additional recall costs are related to replacing AC plugs in the hands of consumers.

Our methodology for estimating the additional recall costs involved estimating future costs to be incurred to replace the recalled AC plug based on expected returns and the costs to conduct the recall, particularly communication, replacement, and transportations costs. Our replacement and transportation cost estimates include costing for component parts and labor; we also obtained third party cost quotes for communication, fulfillment and administration services. The expected percentage of AC plugs to be replaced out of 75,000 units believed to be in the hands of consumers is an important assumption. Our current assumption is that approximately 20 percent of those units in the hands of the consumers will be replaced. To help understand the relative impact of the return rate assumption, a 10 percent point increase in the return rate would increase the estimated additional recall costs from $0.6 million to $0.7 million. We expect our cash outlays associated with this product safety recall to be financed from our existing cash balances.

The decrease in cash generation from fiscal 2001 to fiscal 2002 is primarily due to a significant decrease in current liabilities and amounts accrued in conjunction with the disposition of our non-wireless businesses during fiscal 2001. Also contributing to the decrease in cash generation was a $1.1 million increase in inventory. This increase is related to the introduction of our ChargeSource 70-watt universal DC power adapter that went into production during the third quarter of fiscal 2002. Additionally, during the fourth quarter of fiscal 2002, we also increased our inventory of certain components in anticipation of fourth quarter sales of our wireless test solution

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products. However, fourth quarter sales were lower than anticipated and historical levels. These components were primarily consumed or written off during fiscal 2003.

Cash Flows from Investing Activities

Net cash used in investing activities was $6.2 million for fiscal 2003 compared to $8.7 million for fiscal 2002 and $9.4 million for fiscal 2001. In all periods, capital expenditures for property and equipment, acquisitions, and software development constituted substantially all of our cash used in investing activities. The development of software is critical to our products currently under development.

On July 31, 2001, the Company acquired an 18 percent equity stake in SwissQual for $1.0 million in cash. Based in Zuchwil, Switzerland, SwissQual is a developer of voice quality systems and software for measuring, monitoring, and optimizing the quality of mobile, fixed, and IP-based voice and data communications. Under this alliance, Comarco and SwissQual will jointly develop, sell, and support wireless network quality of service and optimization products for the European marketplace. In addition to expanding our access to European wireless carriers, SwissQual will provide domain expertise and development guidance in the evolution of 2.5G and 3G system test solutions.

On December 7, 2000, we acquired all the outstanding common stock of EDX for 257,428 shares of our common stock, valued at $4.2 million on the day the transaction closed, and $2.3 million in cash.

Cash Flows from Financing Activities

Net cash provided by financing activities was $0.2 million for fiscal 2003 as compared to net cash used in financing activities of $2.2 million for fiscal 2002 and net cash provided by financing activities of $0.5 million for fiscal 2001. In all periods, proceeds from the sales of common stock issued through employee and director stock option plans, offset by the repurchase of our common stock, constituted substantially all of our cash provided by and used in financing activities.

During 1992, our Board of Directors authorized a stock repurchase program of up to 3.0 million shares of our common stock. From program inception through January 31, 2003, we repurchased approximately 2.5 million shares for an average price of $8.22 per share. During fiscal 2003, we repurchased approximately 44,000 shares in the open market for an average price of $9.15 per share.

We believe that our existing cash and cash equivalent balances will provide us sufficient funds to satisfy our cash requirements for at least the next twelve months. In addition to our cash and cash equivalent balances, we expect to derive a portion of our liquidity from our cash flows from operations. As discussed above, certain factors and events could negatively affect our cash flows from operations, including:

We are focused on preserving our cash balances by continuously monitoring expenses, identifying cost savings, and investing only in those development programs and products most likely to contribute to our profitability.

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Critical Accounting Policies

We have identified the following as critical accounting policies to our company: revenue recognition, software development costs, accounts receivable, inventory, income taxes, valuation of goodwill, and valuation of long-lived assets.

Revenue Recognition

We generally recognize product revenue upon shipment of products provided there are no uncertainties regarding customer acceptance, persuasive evidence of an arrangement exists, the sales price is fixed and determinable, and collectibility is deemed probable. For our wireless test solution products that are integrated with embedded software, we recognize revenue using the residual method pursuant to requirements of Statement of Position No. 97-2, “Software Revenue Recognition,” and other applicable revenue recognition guidance and interpretations. Under the residual method, we allocate revenue to the undelivered element, typically maintenance, based on its respective fair value, determined by the price charged when that element is sold separately.

We recognize service revenue as the services are performed. Maintenance revenue from customer support and product upgrades, including maintenance bundled with the original product sale, is deferred and recognized ratably over the term of the maintenance agreement, typically 12 months. Revenue for services under long-term contracts is recognized using the percentage-of-completion method on the basis of percentage of costs incurred to date on a contract, relative to the estimated total contract costs. Profit estimates on long-term contracts are revised periodically based on changes in circumstances and any losses on contracts are recognized in the period that such losses become know.

Significant management judgments must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period if our management made different judgments.

Software Development Costs

We capitalize software developed for sale or lease in accordance with SFAS No. 86, “Accounting for Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.” Software costs incurred subsequent to the determination of the technological feasibility of the software product are capitalized. Our policy is to capitalize the costs associated with development of new products but expense the costs associated with new releases, which consist of enhancements or increased functionality of software imbedded in our existing products. Significant management judgment is required in determining whether technological feasibility has been achieved for a particular software project. Capitalization ceases and amortization of capitalized costs begins when the software product is available for general release to customers. Capitalized software development costs, net of related amortization, are compared to management’s estimate of projected revenues quarterly to determine if any impairment in value has occurred that would require an adjustment in the carrying value or change in expected useful lives under the guidelines established under SFAS No. 86. We also continually evaluate the recoverability of software acquired through acquisition or by direct purchase of technology.

We have $5.6 million of capitalized software as of January 31, 2003, net of accumulated amortization of $3.8 million. Capitalized software amortization expense is included in cost of revenue. The amortization period for the software costs capitalized is the shorter of the economic life of the related product, or based on expected unit sales under the sales ratio method, typically two to four years.

Accounts Receivable

We perform ongoing credit evaluations of our customers and adjust credit limits and related terms based upon payment history and the customer’s current credit worthiness. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Since our accounts receivable are concentrated in a relatively few number of customers, a significant change in the liquidity or financial position of any one of these customers could have a material adverse effect on the collectibility of our accounts receivable and our future operating results.

Specifically, our management must make estimates of the uncollectibility of our accounts receivable. Management analyzes specific customer accounts, historical bad debt, trends, customer concentrations, customer

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credit-worthiness, and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Significant management judgments and estimates must be made and used in connection with establishing the allowance for doubtful accounts in any accounting period. Material differences may result in the amount and timing of our losses for any period if management made different judgments or utilized different estimates.

Inventory

We value our inventory at the lower of the actual cost to purchase and/or manufacture the inventory (calculated on average costs, which approximates first-in, first-out basis) or the current estimated market value of the inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements for the next twelve months. As demonstrated during fiscal 2003, demand for our products can fluctuate significantly. A significant increase in the demand for our products could result in a short-term increase in the cost of inventory purchases while a significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. In addition, our industry is characterized by rapid technological change, frequent new product development, and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Additionally, our forecasts of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. In the future, if our inventory were determined to be overvalued, we would be required to recognize such costs in our cost of goods sold at the time of such determination. Therefore, although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and our operating results.

Income Taxes

We assess our deferred tax assets to determine the amount that we believe is “more likely than not” to be realized. We consider future taxable income and prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If we determine that we will not realize all or part of our net deferred tax assets in the future, we will establish a valuation allowance against the deferred tax assets, which will be charged to income tax expense in the period of such determination.

Valuation of Goodwill

We assess goodwill for impairment annually or on an interim basis whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important that could trigger an impairment review include the following:

When we determine that the carrying value of goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment and the carrying value of the asset cannot be recovered from projected undiscounted cash flows, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. Significant management judgment is required in determining whether an indicator of impairment exists and projecting cash flows.

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In our fiscal year ended January 31, 2003, SFAS No. 142, “Goodwill and Other Intangible Assets” became effective and, as a result we ceased to amortize approximately $10.1 million of goodwill acquired prior to July 1, 2001. We recorded $1.1 million of amortization on these amounts during fiscal 2002. In lieu of amortization, we perform an annual impairment review of our goodwill and indefinite lived intangible balance upon the initial adoption of SFAS No. 142.

During the second quarter of fiscal 2003, we completed the required transitional impairment test under the new rules and recorded a non-cash charge of $2.9 million to write down fully the carrying value of the goodwill related to our EDX reporting unit.

The purchase method of accounting for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired. The amounts and useful lives assigned to intangible assets impact future amortization. If the assumptions and estimates used to allocate the purchase price are not correct, purchase price adjustments or future asset impairment charges could be required.

Valuation of Long-Lived Assets

We evaluate long-lived assets used in operations, including goodwill and purchased intangible assets, when indicators of impairment, such as reductions in demand or significant economic slowdowns that negatively impact our customers or markets, are present. Reviews are performed to determine whether the carrying value of assets is impaired based on comparison to the undiscounted expected future cash flows. If the comparison indicates that there is impairment, the impaired asset is written down to fair value, which is typically calculated using a weighted average of the market approach and the discounted expected future cash flows using a discount rate based upon our cost of capital. Impairment is based on the excess of the carrying amount over the fair value of those assets. Significant management judgment is required in the forecast of future operating results that is used in the preparation of expected discounted cash flows. It is reasonably possible that the estimates of anticipated future net revenue, the remaining estimated economic life of the products and technologies, or both, could differ from those used to assess the recoverability of these assets. In that event, additional impairment charges or shortened useful lives of certain long-lived assets could be required.

Recent Accounting Pronouncements

In April 2002, the FASB issued SFAS No. 145, “Rescission of the FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145 eliminates the requirements to classify gains and losses from the extinguishment of indebtedness as extraordinary, requires certain lease modifications to be treated the same as a sale-leaseback transaction, and makes other non-substantive technical corrections to existing pronouncements. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002, with earlier adoption encouraged. Management does not believe that the adoption of this standard will have a material impact on our results of operation or financial position.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Exit or Disposal Activities.” SFAS No. 146 addresses the recognition, measurement, and reporting of costs associated with exit and disposal activities, including restructuring activities. SFAS No. 146 also addresses recognition of certain costs related to terminating a contract that is not a capital lease, costs to consolidate facilities or relocate employees and termination of benefits provided to employees that are involuntarily terminated under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred compensation contract. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. We are in the process of evaluating the adoption of SFAS No. 146 and its impact on our results of operations or financial position.

In October 2002, the Emerging Issues Task Force (“EITF”) issued EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” The EITF indicated that this guidance is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We are currently assessing the impact of the adoption of these issues on our financial position and results of operations.

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In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34.” This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after December 31, 2002 and are not expected to have a material effect on our financial statements. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002, and the Company does not have any guarantees.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002 and are included in the notes to the accompanying consolidated financial statements.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.” This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. The application of this Interpretation is not expected to have a material effect on our financial statements. The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that we will consolidate or disclose information about variable interest entities when the Interpretation becomes effective. The Company has no variable interest entities which would require disclosure or consolidations under FIN No. 46.

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Currency Risk

We are exposed to the risk of changes in currency exchange rates. As of January 31, 2003, we had no material accounts receivable denominated in foreign currencies. Our standard terms require customers to pay for our products and services in U.S. dollars. For those orders denominated in foreign currencies, we may limit our exposure to losses from foreign currency transactions through forward foreign exchange contracts. To date, sales denominated in foreign currencies have not been significant and we have not entered into any foreign exchange contracts.

Interest Rate Sensitivity

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we have invested in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline in value. To minimize this risk, we maintain a significant portion of our cash balances in money market funds. In general, money market funds are not subject to interest rate risk because the interest paid on such funds fluctuates with the prevailing interest rate.

We do not hold any derivative financial instruments.

Our cash and cash equivalents have maturities dates of three months or less and the fair value approximates the carrying value in our financial statements.

Equity Price Risk

Our short-term investments consist primarily of balances maintained in a non-qualified deferred compensation plan funded by our executives and directors. We value these investments using the closing market value for the last day of each month. These investments are subject to market price volatility. We reflect these investments on our balance sheet at their market value, with the unrealized gains and losses excluded from earnings. We have also invested in equity instruments of SwissQual, a privately held company. We evaluate whether any decline in value of certain public and non-public equity investments was other than temporary. We had no such impairments during fiscal 2003.

Due to the inherent risk associated with some of our investments, and in light of current stock market conditions, we may incur future losses on the sales, write-downs, or write-offs of our investments. We do not currently hedge against equity price changes.

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COMARCO, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

All other schedules are omitted because the required information is not present in amounts sufficient to require submission of the schedule or because the information required is included in the consolidated financial statements or the notes thereto.

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INDEPENDENT AUDITORS’ REPORT

The Board of Directors and Stockholders

Comarco, Inc.:

We have audited the consolidated financial statements of Comarco, Inc. and Subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Comarco, Inc. and Subsidiaries as of January 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended January 31, 2003, in conformity with accounting principles generally accepted in the United States of America. 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.

As discussed in Notes 2, 5, and 11 to the consolidated financial statements, effective February 1, 2002, Comarco, Inc. and subsidiaries adopted the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” as required for the accounting for goodwill and other intangibles assets.

KPMG LLP

Orange County, California

March 28, 2003

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COMARCO, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)